ECB’s Lane: High Level of Two-Sided Uncertainty; Hard to Determine Underlying Inflation

22 September 2023

By David Barwick – FRANKFURT (Econostream) – European Central Bank Executive Board member Philip Lane on Friday said that various factors would make the ECB’s assessment of inflation in the near term especially difficult and that wage trends in particular would resist analysis for many months.

In a speech at the Money Marketeers of New York University, Lane highlighted the ‘high level of two-sided uncertainty around the baseline’, which necessarily made the question of level and duration of monetary policy restrictiveness data-dependent.

The ‘significant role’ of base effects in inflation over the next months would impede efforts to determine underlying developments, he said. Wages and profits would be key questions, but ‘[i]t will be well into the new year before the area-wide 2024 wage trends become fully visible: this fundamental source of uncertainty will not be resolved any time soon.’

Along with faster growth in wages and profit margins, an increase in expectations or higher energy and food costs could threaten the inflation outlook ahead, he said. Softer demand in the wake of tighter monetary policy or global economic weakness was a downside inflation risk, he said.

‘The risks to economic growth are tilted to the downside’, he said. ‘Economic growth could be slower if the effects of monetary policy are more forceful than expected or if the world economy weakens owing, for instance, to a further slowdown in China.’

‘That said, growth could be higher than projected if the strong labour market, rising real incomes and receding uncertainty mean that people and businesses become more confident and spend more’, he said.

Meanwhile, job markets were showing ‘signs of losing momentum’, he said, with employers ‘more reluctant to hire in the face of deteriorating demand and gloomier prospects for the year ahead. In addition, strong labour demand has begun to moderate, with indicators of job vacancy rates edging down in recent months.’

Without being specific about coming monetary policy decisions, Lane explained last week’s rate hike by noting that data had generally confirmed the inflation outlook, that underlying pressures were softening and that policy transmission was ‘firmly taking hold.’

Economic weakening would continue in the short run, with activity set to be ‘considerably lower’ than anticipated, he said. ‘The resulting additional slack will further contribute to the disinflation process, while a significant portion of the tightening from our past rate hikes is still in the pipeline’, he said.

Last week’s hike would help the ECB achieve price stability by bolstering confidence in a timely return to the target and because ‘a higher level of the interest rate will more strongly limit the amplification of any upside shocks to the inflation path, in view of the interaction dynamics between inflation shocks and the overall demand environment’, he said.

‘It follows that, all else being equal, a more secure pace of disinflation and greater insurance against upside risks will also reinforce the anchoring of inflation expectations, which remains a precondition for the disinflation process to keep up its pace’, he added.