The upward trend in interest rates continues relentlessly. Following increases from the US Federal Reserve Board and the Bank of England, the European Central Bank pushed up its key rate by half a percentage point, bringing the total increase since last summer to three points. The cost to many mortgage borrowers is starting to rise significantly now and even many currently on fixed interest rates will face big increases when the term of their current loan deals runs out.
Despite the scale of the increases to date, the message from the ECB is clear. There is more to come. The ECB statement said its intends to announce another half-point rise in March and ECB president Christine Lagarde suggested that there would more increases beyond that, even if the timing and scale of those remained uncertain. Having been caught out by the rapid rise in inflation, the ECB is determined to make up ground now.
The case for the latest increase was made by Lagarde. The latest inflation figures show the headline rate falling, but remaining at a high 8.5 per cent, while so-called core inflation, excluding energy and food, remains stuck over 5 per cent.
The ECB is worried that getting inflation back down to the target level of 2 per cent will not be easily achieved – and argues that it is better to take the economic pain of getting this done now, rather than let inflation get entrenched. The question, however, is how much pain this may impose on households and businesses and whether the ECB risks moving too far, too fast.
The unusual supply-side pressures, particularly from the energy market, which have been the main forces setting inflation on an upward course, mean this is a difficult call. Typically there is a significant lag before an interest rate increase has its full economic impact– meaning that it would only become evident in hindsight if the ECB had gone too far. Equally, it is very difficult to forecast how quickly inflation will now come down and whether some predictions that it could remain stuck stubbornly above target levels may prove correct.
Against this backdrop, central banks, including the ECB, need to be cautious and to be guided by the emerging data. There has certainly been a justification for increasing interest rates over recent months as inflation soared. Now, however, growth is slowing and inflationary pressures are easing. The outlook is uncertain. It seems sensible to wait and see what figures now emerge to decide what further increases are justified and when.
The ECB says that its policies are driven by the data, but is also signalling significant further increases, including a rise in March. What if updated ECB forecasts and new data show inflationary pressure easing? Further increases from here on need to be based on the evidence.