Impact of ECB Rate Hikes Well Underway, but Beware of Longer Lags, Makhlouf Says

4 April 2023

By Xavier D’Arcy – FRANKFURT (Econostream) – The impact of the European Central Bank’s rate hikes on the real economy is well underway, but policymakers should be wary of longer lags in transmission, Governing Council member Gabriel Makhlouf said on Tuesday.

Makhlouf, who heads the Central Bank of Ireland, said at a Market News International event that a wage-price spiral remained a key upside risk to inflation and would require a stronger policy response.

‘With regards to the transmission of monetary policy, the pass-through into financial conditions is well underway’, he said, noting that interest rates on loans to firms and households increased sharply since the beginning of 2022.

‘Meanwhile, we must remain alert to the longer lags in the transmission of monetary policy to growth and inflation’, he said. ‘It will be important to assess how monetary policy decisions to date are working through the economy when calibrating further decisions.’

He warned that ‘a prolonged period of higher wage demands and/or increasing profit margins could drive the persistence of underlying inflation in the euro area.’ Such a situation ‘would call for a stronger monetary policy response in order to mitigate against the risk of this even more persistent inflation’, he said.

The was ‘potential for profit margins to absorb some of this near-term higher wage growth’, he said, adding that wage growth had not matched the growth of profit margins in many sectors since 2019.

Despite falling headline inflation, indirect effects were ‘still working their way through the economy as the input price increases we saw last year pass through more slowly into core inflation, and domestic cost pressures emerge in the form of wages and profit margins’, he said. ‘Monetary policy must ensure that this does not become a source of persistent inflation above our 2% target.’

‘So far, there has been no indication that expectations have become de-anchored from our inflation target’, he noted.

Like many of his Governing Council colleagues, he refrained from giving any concrete indication of the ECB’s next policy move. He said that the ECB’s latest macroeconomic projections showed ‘that our monetary policy tightening is taking effect, but we must remain steadfast, and ready to act as required’.

‘Policy rates will need to be kept at a restrictive level to dampen demand’, he said. ‘This will help to re-set the balance between supply and demand in the economy and bring down inflation.’