ECB’s Lane: Monetary Policy Adjustment ‘Clearly Tightening Financial Conditions’

16 February 2023

By David Barwick – FRANKFURT (Econostream) – The European Central Bank’s monetary tightening has been exerting a clear impact, ECB Executive Board member Philip Lane said Thursday.

In a speech at the National Institute of Economic and Social Research in London, Lane observed that the ECB had flagged its intention to hike by 50bp next month and to then assess the monetary policy outlook, where the latter would ‘involve judgements on the impact of the monetary policy adjustments that have already occurred’.

Whilst this impact would chiefly be felt only over the next two to three years, there are ‘more timely signals’ that ‘for the most part point to a strong and orderly transmission’, he said. Still, the ultimate effect is a matter ‘that can only be settled conclusively at a more mature stage of the process’, he said.

‘Our models indicate that the significant policy tightening that we initiated in December 2021 has had substantial effects on euro area financing conditions so far, while its transmission to real activity and inflation is also starting to materialise’, he said.

The inflation reduction attributed to ECB policy tightening was estimated at 0.2 point this year, 1.2 points this year and 1.8 points in 2024, he said. GDP growth would be reduced by an estimated average of 1.5 points over the same period, he said.

‘These are sizeable effects’, he said. Whilst indicating the danger to price stability of not having acted, they also underscore that ‘excessive tightening could see overshooting and a return to persistently below-target inflation.’

QT also affected the ECB’s overall stance, he said, with models indicating that a €500 billion balance sheet reduction over three years would lower inflation by 0.15 point and GDP growth by 0.2 point.

Next to a model-based evaluation, Lane also undertook a ‘more granular and data-driven analysis’ of the impact of ECB tightening. In this context, he deemed the pass-through to short-term money market rates to have been nearly total and to have fed through to longer maturities.

Banks are passing on their increased funding costs and consumers ‘are incorporating the impact of higher interest rates in their economic decisions’, he continued.

Long-term inflation expectations ‘have so far remained well anchored’, Lane found. Market-based inflation compensation measures’ behaviour following the Council’s decision in December illustrates monetary policy’s contribution to this anchoring, he said.

All in all, he said, available information permitted the ‘interim assessment that our monetary policy actions are clearly tightening financial conditions, reducing credit volumes and altering the behaviour of households and firms.’

‘At the same time, much of the ultimate inflation impact of our policy measures to date is still in the pipeline’, he continued. ‘Over time, our monetary policy will make sure that inflation returns to our target in a timely manner.’

Still, uncertainty requires ‘an open mind about the precise scale of the monetary policy tightening that will be needed’, he said, and the ECB need to keep assessing its stance in the light of new data.

‘The Governing Council’s data-dependent, meeting-by-meeting approach to setting interest rates is well suited to facilitating the necessary ongoing analysis of these issues’, he said.