© Reuters. FILE PHOTO: Croatia’s central bank governor Boris Vujcic speaks during an interview with Reuters in Zagreb, Croatia, January 21, 2016. To match CROATIA-CENBANK/ REUTERS/Antonio Bronic/File Photo
By Balazs Koranyi
ZAGREB (Reuters) – The European Central Bank needs to keep raising rates beyond March and must hold them at high levels for a while even as inflation falls and this “sacrifice” becomes more difficult to explain to the public, the ECB’s newest policymaker said.
Having raised rates by 3 percentage points since July, policymakers have started to ponder when and where the fastest tightening cycle in ECB history will end, especially since inflation is now retreating quickly from record highs.
But Croatian central bank Governor Boris Vujcic, whose nation joined the euro on Jan. 1, says stubborn underlying inflation means it is premature to predict the end of rate hikes and the cut priced in by markets for the turn of the year is not even worth discussing.
“We are likely to see more rate action beyond March and I would leave the issue of the terminal rate for later,” Vujcic, a career economist, university professor and Croatia’s central bank chief for the past decade told Reuters.
“Then typically you would keep the rate there for some time until you are confident that the inflation is back to where you want it to be,” he said in an interview.
Seen as a policy hawk like most governors from Europe’s former communist east, 58-year-old Vujcic has already attended ECB meetings through much of 2022 and has another year and a half left in his term.
With energy prices sharply down compared to 2022 highs and supply chains constraints easing, the ECB could cut its own inflation projections next month, Vujcic said.
And there is a possibility that price growth falls back to , one the ECB’s 2% target more quickly than now expected, he added.
GRAPHIC: Euro zone inflation expectations – https://fingfx.thomsonreuters.com/gfx/mkt/byprlknxqpe/Pasted%20image%201676018837733.png
Still, that is not a signal that the ECB’s job is done, the Croatian argued.
“There is a possibility that headline inflation will fall to 2% much sooner than expected due to various factors … (that) bring the headline figure down sharply, below core inflation,” Vujcic said.
But the ECB needs to see a sustained decline in underlying inflation, which strips out volatile food and energy prices, as this figure is a more reliable indicator of underlying price pressures and the effectiveness of monetary policy.
Dutch central bank chief Klaas Knot has also warned that headline inflation could fall below underlying prices.
This is because lower gas prices are set to drag down the overall rate quite quickly while core inflation is proving unexpectedly stubborn due to a host of factors from wages to the second-round impacts of past inflation on prices.
GRAPHIC: The race to raise rates – https://www.reuters.com/graphics/CANADA-CENBANK/zjpqjwaolvx/chart.png
The problem is that while public tends to look at headline inflation, the ECB will have to watch underlying prices as well, taking into account that the final phase of cutting inflation may be the most difficult.
“In this case, monetary policy has to be restrictive enough to push the core inflation downwards, which is not an easy task as it could imply relatively high sacrifice ratio,” Vujcic said.
Economists call sacrifice ratio the loss suffered in order to achieve a reduction in the long-run inflation rate.
It tends to be lower when inflation is coming down from high levels and usually increases in the “last mile” of disinflation, as price growth is approaching the target.
“We would have to explain to public why we are keeping restrictive monetary policy stance if headline inflation already fell,” Vujcic said.
A possible good news for the ECB is that the economy has appeared to avoid the worst of the economic downturn and prospects for a soft landing have improved.
Click here for excerpts of this interview.
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The European Central Bank (ECB) must carry on raising interest rates, despite sacrifices from the public, said ECB Governing Council member Zeljko Vujcic.
Reacting to speculation that the ECB may be tempted to slow rate hikes due to the public’s burden, Vujcic said that policy makers must focus on broader monetary goals and leave public considerations to individual governments.
“We can’t make a decision on interest rates only on the basis of who’s suffering,” he said in a Bloomberg Television interview in Vienna.
Vujcic noted that he favored the ECB’s withdrawal from quantitative easing (QE): a program of pumping money into the financial system to stimulate the economy. He said that the bank should now focus on increasing rates to a more sustainable level to prevent future financial imbalances.
“It’s time that monetary policy is normalized so that some of the conditions that allowed the buildup of too much debt in the economy are avoided in the future,” Vujcic said.
He added that governments have the tools to limit the burden on the public, such as tax policies, and should take responsibility for amplifying or softening the effects of the ECB’s rate changes.
Vujcic’s comments echo the official standing of the ECB leaders, who earlier this month agreed to hold interest rates at current levels and suggested they had no need to change. However, they also said that they would need to continue to monitor the situation, making any continued rate hikes a possibility.
In conclusion, the ECB must continue to raise interest rates, regardless of potential public sacrifices, according to ECB Governor Council member Zeljko Vujcic. He suggested that governments should take responsibility for amplifying or softening the effects of ECB rate moves, according to their own policies.
