ECB’s Lane: Inflation Going to Come Back Down, and Not Just Because ECB Is Tightening

3 October 2023

By David Barwick – VILNIUS (Econostream) – European Central Bank Executive Board member Philip Lane on Tuesday said that monetary tightening in the euro area and other jurisdictions was showing up in various price measures and that disinflation, also at the level of consumer prices, would continue.

During a panel discussion at a conference of the Bank of Lithuania, Lane made the following key comments that we reproduce here:

‘If you go back to our assessment at the end of ’22, it’s more or less on track. So, there was an assessment that this year, energy prices would calm down, food prices will calm down - but that’s happening more slowly than we would have liked – good prices would calm down, and services inflation would be the element that will take a couple of years to play out, because the fact that wages do have to increase this year, it’s natural to have further increases above normal next year and indeed again in ’25. So … it does help to explain why inflation doesn’t just collapse back to 2%. There is a tail. And in that tail of a year or two, there is the issue about, if people … say, “Well, you know, I thought this was going back to 2[%], why is it at 2.7 or 3 or whatever?” … And also … it moves quite slowly next year back towards 2. So next year will be big, I think, communication challenge to explain why progress is not super-fast, but at the same time, you should be confident we will get back to 2%.’

‘So, our whole project this year and facing it for the next couple of years is, is that [demand] environment changing? And this is where monetary policy plays a role. So, essentially now, with the hiking, the demand conditions have changed. People are now thinking twice about consumption. They’re thinking twice about investment. And that’s even more so for people whose incomes are being depleted by bigger payments on their mortgages. So, in that demand environment, the economic incentives facing firms changes. … They may have no choice in some cases to pay higher wages. Please remember, in a lot of Europe there are legislated increases in minimum wages. And so if you’re in a sector where there are a lot of people on a minimum wage, you cannot control that directly. And then the question is, “Can I pass this on to the consumer, or do I have to absorb it in lower profits?” And what we essentially have in our assessment would be a mix. It would be the case that we will still have services inflation above normal for a while, but it’s also the case, having made a lot of money last year, and also by the way hiking prices in anticipation of the fact that their labour costs would probably go up this year, we think there is some room for profits to normalise. … You can go a long way with just thinking about the economic incentives facing firms, and the unique opportunity last year to raise prices.’

‘So, when we say inflation is going to come back down, it’s not just because of the ECB, it’s the fact the Fed is tightening, the Bank of England, the Riksbank. … Where it’s needed, a lot of central banks are tightening. And we see this already in commodity prices, intermediate prices, producer prices. … A lot of these prices have moved quite a bit, and the last kilometre in pricing dynamics is to see this also show up in consumer prices. And, you know, our analysis suggests we should see more of that.’

‘We’re probably in a zig-and-zag kind of pattern back to 2%.’

‘So, we have a 2% target. If something takes us away from 2%, we will move our monetary policy to bring us back. But right now, the betting is there may well be upside shocks rather than downside shocks. But that’s a kind of point-in-time guess; let’s see how it plays out.’

'We are responsible for price stability. We are not outsourcing our responsibility. But how we get to 2% clearly depends on the fiscal decisions. So, it doesn't say it's an excuse or a reason not to get to 2%. ... There's always lots of interaction. They need to have a clear understanding of us, we need to have a clear understanding of fiscal policy.'