Eurozone inflation is already below the European Central Bank’s 2% target, prompting a new policy debate: should the ECB keep trying to look tough on inflation, or relax and give the economy more room to breathe?
Annual inflation fell to 1.7% in September and GDP growth in the second quarter was a measly 0.6%.
After cutting interest rates at its monetary policy meeting last week, the ECB said inflation was expected to rise in the coming months because previous sharp falls in energy prices would drop out of the annual rates. “Inflation should then decline to target in the course of next year,” it said, adding that “The risks to economic growth remain tilted to the downside.”
Robert Holzmann, governor of Oesterreichische Nationalbank, Austria’s central bank, told GlobalMarkets monetary policymakers should prefer to have inflation below the target.
Often seen as a spokesman for the ECB’s hawkish wing, Holzmann said undershooting 2% would be beneficial, to reinforce the central bank’s credibility.
“I think at the beginning it makes sense to undershoot, because if you remain at 2.5% people will say we don’t take the 2% target seriously,” he said. “There is quite likely a temporary undershooting of inflation. It’s useful to be first somewhat below the target, before moving back again. But this would not be a failure of monetary policy.”
Banco de Portugal governor Mario Centeno, one of the bloc’s more dovish members, told GlobalMarkets the eurozone had spent the past year repeatedly lowering its expectations for growth and inflation.
“One of the risks we see now for economic activity and inflation is if monetary policy transmission dampens demand more than needed,” he said. “The best place to be is when inflation hovers around 2%. If we tighten too much, we may end up below 2%. And that proved in the past very difficult to overcome. We spent 10 years trying to get inflation [up] to 2% and we failed.”
For 13 years from 2009 to 2022 ECB rates were near or even below zero, before rising fast in the inflation shock of 2022-3.
Centeno said monetary policy in the eurozone remained tight, even after three cuts in the ECB’s policy rate. In June, September and last week, the ECB cut its deposit rate by 25bp, bringing it from 4% to 3.25%.
Centeno said the ECB should be “gradual, consistent and predictable” in bringing rates down to the theoretical neutral level, when monetary policy was neither in tightening nor expansionary mode.
But Holzmann downplayed the suggestion that the ECB was causing low growth in the eurozone, including a recession in Austria. He pointed to factors such as lower growth in China and a rising household savings rate.
“The interest rate at 4% and now 3.25% is not a driving force of too much saving — maybe a little bit at the beginning — and our data shows financing conditions are not a constraint for enterprises,” he said. “Monetary policy is not the primary constraint on growth, it is rather driven by other macro elements.”
Far from failing in its campaign to raise inflation in the 2010s, the ECB might have been “too successful”, Holzmann said.
“A situation may emerge in which we remain a little bit below 2% but it would not be sensible to do the same policy as before, with all forces moving inflation up to 2% — in other words putting a lot of money on the table, which afterwards creates inflation.”