By David Barwick and Marta Vilar – TALLINN (Econostream) – The European Central Bank might not need to wait until broad-based second-round effects are “fully visible” before considering a rate increase, according to ECB Governing Council member Madis Müller.

In an interview with Econostream on Thursday (transcript here), Müller, who heads Eesti Pank, expressed opposition to adjusting monetary policy prematurely or without good reason while arguing that once policymakers were sufficiently confident such effects were very likely, it would already be reasonable to consider hiking.

“Once energy prices have stayed elevated for some time, I am sure we would soon begin to see at least some indirect effects,” he said. “There are goods and services for which energy is a major component of total cost, and prices there are probably already reacting.”

Those early price effects had to be distinguished from the broader second-round effects defined by energy price-driven wage pressures leading to “more persistent, generalized inflationary pressure,” he said.

“I am not sure we need to wait until all of that is fully visible,” he said. “Once energy prices have remained elevated for several weeks, one can already be reasonably confident that second-round effects are likely.”

“At that point, the question naturally arises whether the ECB should respond,” he continued. “I also would not be surprised if, by the next policy meeting, elevated energy prices were already showing up more broadly in the prices of other goods and services. If that happens, we will need to discuss whether that is already enough to justify action.”

Even so, Müller stopped short of advocating an “insurance hike.” He said the ECB should monitor the situation, look at incoming data and be ready to act in a timely way if conditions warranted, but should not do anything prematurely before seeing a clear indication that action was needed.

Nor would he agree that one rate increase would necessarily usher in a sequence. “If we decide to act at a particular meeting, that does not automatically predetermine the next step,” he said, reiterating that policy should remain meeting by meeting.

Müller also signaled little appetite for large increments if tightening did prove necessary. “Very dramatic moves are unlikely to be necessary,” he said. “More generally, measured steps are normally preferable as they come with less of a risk of causing disruption in markets.”

That judgment, he said, reflected the different starting point relative to 2022. Then, rates were at minus 0.5% and inflation was already far above target, meaning the ECB had needed to catch up quickly to a rapidly changing situation, he observed.

Now, by contrast, inflation had been at 2% before the war and interest rates were already around neutral, leaving policymakers “in a much better starting position to respond to whatever happens,” he said.

The Estonian central bank governor, like many of his colleagues, also removed one procedural excuse for delay. Every meeting was live and the absence of a full new round of projections, he said, should not in itself stop the Governing Council from acting in April if action were otherwise justified.

“We can still make technical updates to the scenarios and projections,” Müller said. “And if energy prices remain elevated until then, I think it will already be possible to draw conclusions about the broader effects of the shock.” That meant that the Council could still have the relevant discussion even without a full new set of staff forecasts, he said.

More broadly, Müller said he saw a shared commitment within the Governing Council to keep expectations anchored and not act too slowly if conditions changed. He described that as one of the lessons of 2022, when what many had treated as a temporary energy shock turned out to feed broader inflation more quickly and more powerfully than expected.

He was explicit on that point. “One important lesson from 2022 is that a substantial energy price shock can feed into broader inflationary pressure relatively quickly,” he said. The view some had held in late 2021 and early 2022 “that the shock would be temporary and would not lead to generalized inflation” had not been justified, he said.

Müller added that the euro area labor market currently remained very tight, with record-low unemployment, and that this could create the conditions for second-round effects if energy prices stayed elevated for an extended period. If policymakers wanted to know whether those effects were becoming entrenched, he said, wages would be one of the main things to watch.

“Yes, certainly,” he said when asked whether wages would be one of his triggers for acting. “If that trend [of wage deceleration] were suddenly to reverse, that would be a clear sign of second-round effects emerging. We would need to take that very seriously, and it would argue in favor of higher rates as evidence that the energy shock was feeding more broadly into inflation.”

On timing, Müller noted that the ECB would get another Eurostat labor-market reading on April 1, but stressed that policymakers would also be looking at unemployment, the ECB wage tracker, negotiated wages, national wage developments and broader inflation metrics by the time of the next meeting.

He also argued that the current shock differed from 2022 in important ways. “Another important difference from 2022 is that the supply chain bottlenecks we still had back then are largely absent now,” he said.

“This energy shock is also more global in nature,” he said. “In 2022, the issue centered on Russia and Europe’s effort to replace Russian gas and oil. Now we are dealing with disruptions to supply across the Middle East, and those are felt globally and immediately.”

And even if the conflict ended quickly, he said, echoing comments made this week by ECB President Christine Lagarde, the effects might persist. “[E]ven if the war were resolved immediately, some infrastructure has been damaged, so oil and gas supply could not simply return overnight to previous levels,” he said. “That means the effects could be more persistent.”

Müller nonetheless did not describe the growth backdrop in alarmist terms. “I do not think it is appropriate to speak of stagflation. To me, that remains a tail risk,” he said.

That was not because the shock was unimportant, he made clear. A week ago, when the ECB discussed the projections, oil prices had already been significantly above the levels assumed as of the March 11 cutoff date, he said, so there had already been a sense that the baseline might be somewhat too optimistic. But even with both growth and inflation affected, he still expected the euro area economy to continue recovering gradually.

He also declined to say a hike had become likely in any strong sense. “There is still a scenario in which rates do not need to rise,” he said. But when asked whether that meant the no-hike outcome had become an optimistic one, he agreed that it had.

“The longer the war in the Middle East lasts, and the longer energy prices remain elevated, the more likely it becomes that we will have to respond as second-round effects emerge,” Müller said. Even so, he refused to attach precise probabilities to those scenarios, saying it was still too early to tell whether the chance of a hike had risen above 50%.

Asked where the euro area now stood relative to the ECB’s scenarios, Müller said, “We may be somewhere between the baseline and the adverse scenario.” The jump in oil prices during last week’s Governing Council meeting had suggested movement toward the adverse case, he said, though lower prices and somewhat greater optimism about the conflict since then meant the euro area was not clearly there.