A larger “sacrifice” will be needed to tame inflation than in previous bouts of monetary policy tightening, according to European Central Bank officials who warned that price growth risks spinning out of control if forceful action is not taken.
Isabel Schnabel, an ECB executive board member, and François Villeroy de Galhau, governor of the Banque de France, said on Saturday that European monetary policy would have to remain tight for an extended period of time.
Their remarks at the Jackson Hole gathering of central bankers from around the world in Wyoming, US, echoed those of Federal Reserve chair Jay Powell, who on Friday made an “unconditional” commitment to quash inflation.
The pace of price growth is running at a level not seen for decades in many advanced economies.
“Central banks are likely to face a higher sacrifice ratio compared with the 1980s, even if prices were to respond more strongly to changes in domestic economic conditions, as the globalisation of inflation makes it more difficult for central banks to control price pressures,” Schnabel said.
The sacrifice ratio measures how much pain central banks will need to inflict in terms of weaker growth and lower job creation in order to bring inflation back under control.
Villeroy said there should be “no doubt” about the bank’s willingness to raise rates beyond the so-called neutral rate, a level that neither aids nor constrains growth. He estimated this rate to be between 1 and 2 per cent. Villeroy said it could reach this level “before the end of the year”, adding: “Our will and our capacity to deliver on our mandate are unconditional.”
Eurozone inflation is expected to set a new record of 9 per cent in the year to August when the latest data is released on Wednesday.
Schnabel called for “strong determination to bring inflation back to target quickly”. She added that if a central bank “underestimates the persistence of inflation — as most of us have done over the past one and a half years — and if it is slow to adapt its policies as a result, the costs may be substantial”.
The ECB ended eight years of negative interest rates last month by raising its deposit rate by a half percentage point to zero, surpassing its earlier guidance. Some members of its 25-person governing council are calling for it to consider going further with a 0.75 percentage point rate rise at its meeting on September 8.
Schnabel, a former German economics professor who joined the ECB board at the start of 2020, is one of the central bank’s most influential voices on policy as its head of market operations. She warned that “unprecedented pipeline pressures, tight labour markets and the remaining restrictions on aggregate supply threaten to feed an inflationary process that is becoming harder to control the more hesitantly we act on it”.
Inflation expectations are rising among the public and professional forecasters, many of whom expect prices to keep rising by more than the ECB’s 2 per cent target for several years, Schnabel said, adding that the institution’s credibility was at stake.
“Both the likelihood and the cost of current high inflation becoming entrenched in expectations are uncomfortably high,” said Schnabel. “In this environment, central banks need to act forcefully.”
Villeroy — usually a centrist on the ECB governing council — echoed the hawkish tone. But the French central bank governor signalled that he still thought a 0.5 percentage point rate rise would be enough next month, saying he favoured “another significant step in September”.
The comments come a day after Powell reset expectations about how high interest rates in the US might need to rise and for how long, as the Fed grapples with excessive price pressures driven in part by supply-related factors but also excessive demand.
The US central bank chair warned that efforts to cool the economy were likely to require a “sustained period” of low growth, a weaker labour market and “some pain” for households and businesses.
Like his counterparts at the ECB, Powell said a failure to successfully tame inflation now would lead to higher costs later on, suggesting the Fed is unlikely to pause its tightening cycle anytime soon.
In contrast, speaking from the audience during the Q&A section of the Jackson Hole panel, Haruhiko Kuroda, governor of the Bank of Japan, set out why his country was not aggressively tightening monetary policy.
“We have no choice other than continue monetary easing until wages and prices rise in a stable and sustainable manner,” he said. Kuroda projected that Japanese inflation would approach 3 per cent by the end of this year and then decelerate towards 1.5 per cent next year.