The European Central Bank may need to keep raising interest rates given an abundance of upside inflation risks, though the timing and size of any move remain far too uncertain to predict, according to ECB policymaker Primoz Dolenc. As reported by Reuters, Dolenc, who is also governor of Slovenia's central bank, said persistently elevated inflation that the ECB sees in its September projection and the lack of resolution of conflicts in the Middle East, Ukraine and elsewhere, supports the case for moving policy rates towards a more restrictive territory. He added that future decisions would be taken on a meeting-by-meeting basis based on incoming data, with the ECB continuing to assess whether higher energy costs linked to the Iran war could become embedded more broadly in the euro zone economy.
The ECB has raised its deposit rate twice this year to 2.5% as inflation accelerated to 3.8% last month, nearly twice the central bank's 2% target. According to Reuters, policymakers are now scrutinising the data to determine just how much more tightening is needed to prevent an Iran-war induced energy cost surge from getting embedded. However, the composition of recent inflation data offers some reassurance, with the latest increase largely driven by energy prices while core inflation has remained relatively stable, indicating limited pass-through to underlying inflation components, particularly services. Dolenc noted that core inflation has remained relatively stable, suggesting limited pass-through to underlying inflation components, providing some reassurance that broader inflationary pressures remain contained.
Dolenc said risks to the inflation outlook remained tilted towards higher prices, particularly because of uncertainty surrounding energy markets. As reported by Reuters, European gas storage levels ahead of winter are a concern, with any renewed increase in wholesale gas prices potentially passing through to consumers relatively quickly. Food prices could also come under pressure from the combination of high input costs, drought conditions and the effects of El Niño. The euro zone's stronger-than-expected economic performance is another potential source of inflationary pressure, with the region's economy expanding at its fastest pace in four years in the second quarter despite expectations that the energy shock would significantly weigh on growth. The energy price surge was expected to wipe out most of the bloc's growth this year but the economy is showing resilience, growing at its quickest rate in four years, well above its potential.
Higher longer-term borrowing costs have emerged as a potential downside risk to growth, with ECB Executive Board members Philip Lane and Isabel Schnabel warning that rising yields could hold back the economy more than predicted. According to Reuters, financial analysts are especially worried about the rising premium investors demand to hold French debt, prompting debate over whether the ECB could eventually intervene in bond markets. However, Dolenc played down concerns over a disruption in monetary policy transmission, saying monetary policy is transmitted more or less homogeneously into broader financial conditions all over the euro area and that they haven't seen any destructive effect of rising yields on other parts of the economy. He noted that much of the recent economic growth was driven by personal consumption and services spending, which is likely to persist as suggested by survey indicators.
