European Central Bank President Christine Lagarde said Tuesday that the nature of the eurozone’s inflation problem is changing, requiring interest rates to stay higher for longer than policymakers and investors once expected. rice field.
Although the shocks that pushed inflation in the region above 10% late last year, including supply chain bottlenecks during the pandemic and soaring energy prices after Russia’s invasion of Ukraine, are starting to wane, the impact is still spilling over into the economy. are doing. Lagarde said at the central bank’s 10th annual meeting in Sintra, Portugal, that this was further sustaining inflation.
Lagarde said the slowdown in inflation was “caused by the fact that inflation is gradually trickling through the economy as different economic agents try to pass costs on to each other.” Businesses are passing costs on to their customers, and workers are now trying to make up for lost wages due to high prices.
Central bankers from across Europe and from Canada to South Africa, including Federal Reserve Chairman Jerome H. Powell and Bank of England Governor Andrew Bailey, have come to Cintra at a difficult time for policymakers. rally and bring down inflation without causing unnecessary economic pain.
Central banks around the world are raising interest rates aggressively, and while the full impact of these moves is yet to be felt in countries, policymakers are trying to see if they can tackle the inflation problem.
Earlier this month, the European Central Bank, which sets policy for the 20 countries that use the euro currency, raised interest rates to their highest level since 2001 and said more hikes were likely after that. Eurozone consumer prices rose 6.1% in May from a year earlier, the lowest pace in more than a year. But policymakers remain concerned about core inflation pushing down food and energy prices, a way of measuring how deeply price pressures have permeated the economy. The index fell to 5.3% in May from 5.6% the previous month.
Lagarde said on Tuesday that the central bank “must raise interest rates to a sufficiently restrictive level and keep them there for as long as necessary.”
He added that businesses would need to absorb higher wage costs and accept lower profit margins if inflation in the euro zone is to return to the central bank’s 2% target.
Last year, companies were able to pass on higher costs quickly, partly because customers were able to discern whether higher prices were due to higher company costs or the pursuit of higher profits. He said it was because he couldn’t. Profits thus contribute about two-thirds to domestic inflation, averaging one-third over the past two decades.
Workers now demand higher wages to make up for lost purchasing power. The central bank expects inflation-adjusted wages to return to pre-pandemic levels and rise 14% by the end of 2025.
Lagarde said if monetary policy is sufficiently restrained, inflation can be kept in check and workers can make up for some of the lost wages. For this to work, policies need to restrain the economy by dampening demand so that firms cannot fully pass the cost of higher wages onto customers. If that doesn’t happen, inflation will remain high.
Lagarde said the central bank needed to take “more tenacious policies” to deal with signs of prolonged inflation. That means keeping interest rates at a restrictive level until policymakers are convinced the wage catch-up is resolved.
“We’ve made great progress,” Lagarde said. “But in the face of a more sustained inflation process, we cannot waver and declare victory just yet.”
He added that the central bank would not be able to say with any certainty in the short term whether interest rates have peaked.
Overnight, central bankers received a stern warning from the International Monetary Fund. “It’s taking too long for inflation to return to target,” Gita Gopinath, the group’s first deputy managing director, said in a speech.
Gopinath set the tone for the meeting, which runs until Wednesday, arguing that the central bank needs to do more to curb inflation despite the economic costs.
Even with the steps taken by the world’s central banks, “the battle will not be easy,” Gopinath said. “Financial stress could intensify and growth may need to slow further.”
