Interview with CNBC Europe
Interview with Philip R. Lane, Member of the Executive Board of the ECB, conducted by Annette Weisbach
1 April 2022
Many people, consumers and investors alike, are watching the inflation numbers very closely, 7.5% is much higher than many had expected and is causing some concern, what is your reaction to today’s print?
Of course, this is a very high number. Behind the overall inflation rate is a 45% increase in energy inflation between this year and a year ago, and that's a very large – yet another large – step increase from the 32% we had last month.
So clearly here we are at the 1st of April and the war in Ukraine has added further upward pressure, as you just said to energy prices, to commodity prices.
So, this asks the European economy to absorb a 45% increase in energy prices, which in turn is off the scale. And it's pushing up costs across the economy. All of the different sectors behind the overall number are seeing an increase in prices.
This has many, many consequences. So as you said in the introduction, households will be suffering in terms of their purchasing power. Firms face very large energy bills, especially in the most intensive energy sectors. Governments are also, of course, responding in many ways to this energy shock.
So, what we have to do as the ECB, is to analyse the consequences of these very high inflation numbers, which operate through a number of channels. Of course, through inflation dynamics – with these high numbers, there would be more momentum behind inflation through second-round effects and so on.
But we also have to look at the implications for the supply capacity of the European economy – many firms will struggle with these high energy prices – and for demand.
And then maybe the data point to note here is: the war has had many consequences for Europe, and we've also seen in recent weeks a big dip in some sentiment indicators.
So, in our upcoming meetings we will be putting together the first order impact of these very high energy numbers, but also the implications for confidence for real incomes and supply. So it's of course a very major development for us.
You have been referring already to second round effects, especially the wage developments. Are you seeing signs that this is picking up faster than you previously expected, which could also mean a change in your assessment?
What I think we are seeing is it takes time for the wage response to the price increases. So I think early this year we are seeing some signs, but very mild, of wage responses to what's happened so far. But of course, for those who were negotiating wages in maybe in January and in February, that is before these high inflation rates have picked up yet again.
What I would say is that in terms of what's being concluded so far, it remains the case that we see wages are only responding in a very limited way, but of course we have to take into account. And by the way, in our projections we do assume that wages will grow more quickly over the course of this year and into next year.
I suppose really what I'm saying in that is that this is of course on its own terms something that will raise the cost of living, that will reduce our purchasing power and will be surely a factor in wage negotiations to come.
On the other hand, the ability of firms to pay higher wages will have to take into account the fact that firms face higher costs also. And then we have the wider demand environment, where the loss of real income from paying these high energy prices will reduce demand. And on top of that, we have the war situation, where the uncertainty of the war also creates uncertainty and demand conditions.
So, it's a situation where many things are going on. I would summarise it as a situation of uncertainty. And of course this is why in our March decision we emphasised optionality and flexibility in monetary policy.
Because we have to realise under these situations that the correct monetary policy response will depend upon how the data arrive in the coming weeks and months.
So, commentators are suggesting that you are facing a policy dilemma right now because clearly growth estimates are getting downgraded really fast, how much of a headache is that for your policy projections?
With this type of supply shock essentially, and the uncertainty shock, you do have that difficult situation. But in the end, this is why, when we – especially in our quarterly meetings – have a comprehensive assessment and new forecasts, essentially this has to be brought together, informing our medium term inflation outlook.
And what we concluded at the March meeting is, essentially if the medium-term inflation outlook remains in a situation where we think inflation will not be falling below our target in the medium term and over the next couple of years – as you know our forecast for 2024 was a little bit below the targetat 1.9 – in terms of our sequence the first decision will be – if the medium term inflation outlook is maintained – that we will be looking to end net purchases in the third quarter. However, if the outlook deteriorates by so much that the inflation outlook weakens, then we will have to think again. And what we have here is opposing forces: on the one hand, we have the energy shock and the prospect of second round effects are pushing up inflation; on the other hand, as you say, the weakening of sentiment and the fact that real incomes will suffer with the high energy prices – and especially so over a one to two year horizon – will have a negative pressure on the inflation outlook.
This will be why it's going to be a lot of work, a lot of analysis, a lot of debate about the net impact of those opposing forces.
So today, you know this is again highlighting the impact of the war, highlighting really levels of inflation we have not seen. So we have to properly assess this, to take it side by side with the news about sentiment. But by the way, yet another complication is we also have the reopening of the European economy, there is still momentum compared to last year in terms of the normalisation of economic activity. I think it's important that we take our time, and use the forecasting exercises to bring all of that together and form a net assessment in our upcoming meetings.
Given the pushes and pulls that you just described, could we end up in a situation where, if inflation became so problematic for businesses and households, where the economy needs more monetary support rather than less in the months ahead?
Remember what we have now is: we have policies that that were introduced when we had inflation far below target. And what essentially we've been talking all year long is about the appropriate pace of normalisation.
I think it ultimately remains the case that we now have inflation right now well above target, and these considerations you mentioned about possible hits to demand, possible slowdowns of the economy, to me it's really about the appropriate pace of normalisation.
It's not a set of situations where I think additional monetary support compared to where we've been is really, I think, going to be part of the answer. But that reflects the fact that we're coming from a situation of having policies that were introduced to fight excessively low inflation, and that normalisation coming back towards neutral is a very different concept from a kind of situation of tightening.
As you know, the yield curve has been moving all year long, so there's already been tightening going on in terms of financing conditions in a nominal sense, and we will have to assess – when we come to the upcoming forecasts – the net impact of the fact that we do have monetary tightening due to the upward movement in the yield curve.
We do have this inflation pressure right now and then we have all the uncertainties of the war. So yes, it’s not so easy, no obvious answers here. But this is what we will be working on for the coming weeks.