Exclusive: ECB Insider: Stronger-than-Expected Eurozone Economy Favours Council Hawks

12 January 2023

Exclusive: ECB Insider: Stronger-than-Expected Eurozone Economy Favours Council Hawks
- ECB insider: Easier to hike interest rates when labour markets are holding up well

By David Barwick – FRANKFURT (Econostream) – Stronger-than-expected euro area economic developments play into the hands of those on the European Central Bank’s Governing Council who are keen to do more monetary policy tightening, according to a prominent Eurosystem insider who spoke to Econostream recently.

The Eurozone’s resilience in the face of economic headwinds is increasingly evident to policymakers, this person confirmed, noting in particular the November unemployment report released earlier this week showing a further decline, albeit slight, in the number of jobless persons in the region.

A number of Council members have repeatedly said going back months that even a mild downturn – now part of the ECB’s baseline scenario for the end of 2022 and early 2023 – would not by itself be sufficient to get inflation back under control.

While this baseline is not now necessarily being called into question, the yet milder outcome that may actually materialise would support additional policy tightening in two main ways, this person said.

On the one hand, he pointed out, economic robustness implies a general need for monetary policy to step on the brakes a bit harder to, as Executive Board member Isabel Schnabel said in a speech on Tuesday, ‘slow growth in aggregate demand, which is needed to reduce the upward pressure on prices’.

On the other hand, and importantly, he added, monetary policymakers are keenly aware of the undesirability of increasing borrowing costs in an environment of rising joblessness, even if they have insisted for the most part on their willingness to pay such a price for restoring price stability.

The fact that precisely labour markets are still showing buoyancy after the 250bp of hikes to date mitigates this problem and thus ‘makes it easier to do what we need to do’ and hike rates further, he said.

Though left unmentioned on this particular occasion, the resilience of labour markets would naturally also tend to support concerns about the potential for a wage-price spiral, a key issue for policymakers.

The remarks made by this policymaker call to mind related ones by his counterpart from the Bank of Greece, Yannis Stournaras, who in an op-ed piece on December 25 wrote that ‘[a]lthough the central banks' main objective is clear, a policy dilemma arises relating to the extent to which interest rates should be increased and thus the negative consequences for economic growth that monetary authorities will be able to accept in order to stabilise inflation over the medium term.’

Put in those terms, the surprisingly durable performance of the euro area economy is seen by the insider Econostream spoke to as tending to resolve the dilemma.