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The head of Germany’s central bank has warned that eurozone inflation is still falling too slowly, pushing back against investors’ hopes that the European Central Bank will stop raising interest rates.
Bundesbank president Joachim Nagel said policymakers must avoid a scenario where high prices become “entrenched” in the eurozone economy “at all costs”, adding that inflation is “only expected to fall gradually”.
Economists believe major central banks are getting closer to the end of their aggressive rate increases to combat inflation after the US Federal Reserve held its policy rate unchanged on Wednesday. The Bank of England also kept rates unchanged at 5.25 per cent on Thursday after UK inflation was much lower than expected in August.
But the hawkish comments by Nagel, who is a member of the ECB’s rate-setting governing council, contrast with widespread investor expectations that last week’s 10th consecutive increase in eurozone borrowing costs would be the last.
“Was that it for raising the key interest rates?” said Nagel. “Have we reached the plateau? This cannot yet be clearly predicted. The inflation rate is still too high. And the forecasts still show only a slow decline towards the [ECB’s] target value of 2 per cent.”
After his speech in Frankfurt, the yield on Germany’s rate-sensitive two-year bonds rose close to a six-month high of 3.32 per cent, reflecting market sentiment that the ECB may raise rates further.
The ECB last week raised its benchmark deposit rate by a quarter percentage point to an all-time high of 4 per cent, up from a record low of minus 0.5 per cent last year.
Other European central banks continued to raise borrowing costs this week, including those in Sweden and Norway, which both increased rates by a quarter point on Thursday. However, the Swiss central bank surprised analysts by keeping rates unchanged.
Eurozone inflation dipped to 5.2 per cent in August, down from 5.3 per cent in July and a peak of 10.6 per cent last year. Analysts are expecting a bigger drop when the September price data is published next week. Derivative investors are pricing in only a 10 per cent chance of another rate rise by the ECB at its policy meeting next month.
UBS economist Anna Titareva forecast eurozone inflation would fall to “the lowest in almost two years”, hitting 4.4 per cent in September. She added: “We now expect the ECB to keep rates on hold until June 2024, and then start cutting rates by 25 basis points per quarter.”
The latest sign that price pressures are subsiding from peaks reached last year following Russia’s invasion of Ukraine came with the release of German industrial producer prices. Data showed they fell at a record annual rate of 12.6 per cent in August, despite increasing 0.3 per cent from July.
Nagel warned there was a risk of high inflation “becoming entrenched” if consumers and businesses expected it to remain high and pushed up wages and prices accordingly. This increased the need to let rates “remain at a sufficiently high level for a sufficiently long time”, with the exact duration depending on the data, he added.
“If monetary policy got behind the curve, [the ECB] would have to raise interest rates faster or more to catch inflation again,” he said. “That would place even greater strain on the economy. I would like to avoid this scenario at all costs.”
Some ECB rate-setters echoed Nagel’s warning on Thursday. Martins Kazaks, Latvia’s central bank head, said the recent rise in oil prices “does create upside risks in my view for inflation”, adding that he would not rule out another rate rise.
Gabriel Makhlouf, head of Ireland’s central bank, told the Irish Independent: “I’m not saying that at our next meeting we’re going to hold.”
However, Pablo Hernández de Cos, Spain’s central bank governor, said keeping the ECB’s deposit rate at 4 per cent for “a sufficiently long time should be broadly consistent with achieving our inflation target”.
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