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Rising labor costs will eventually reignite inflation in the euro zone and the European Central Bank is on track toward its goal, according to the institution’s chief economist, Philip Lane.
“The fraction of the price level which is most likely to be influenced by wage pressures is moving closer toward the target,” Lane said in an interview with the Financial Times published Sunday evening. “There cannot be a permanent disconnect between labor costs and prices.”
The comments by the Executive Board member highlight the ECB’s determination to continue pumping cash into the financial system via negative interest rates, bond purchases and ultra-cheap loans to banks.
Its credibility is at stake though, after years spent missing its inflation goal despite such massive support. In contrast, the U.S. hasn’t had to implement negative rates, in part because the American economy has had the fiscal support that the euro zone lacks.
“Clearly, we are closer to the lower bound than the Federal Reserve is,” Lane said. “We are closer to it than we would like to be.”
Lane was a key proponent behind a polarizing decision in September, under then-President Mario Draghi, to step up monetary stimulus with another rate cut and the resumption of quantitative easing. Now, under new President Christine Lagarde, the ECB is embarking on a strategic review that will focus on the reasons why it has fallen short.
Suggestions so far have included making the target more specific at precisely 2% -- instead of the current “below, but close to, 2%” -- and possibly adding a band of tolerance around it. At least one policy maker, Austrian Governor Robert Holzmann, favors lowering the goal to reflect downward price pressures that are outside the central bank’s control, such as globalization.
Lane also acknowledged that the ECB will consider whether its measures of inflation should take better account of housing costs, which are currently severely under-weighted. He’s started presenting adjusted figures that give extra weight to housing in rate-setting meetings, saying they are about 20 to 30 basis points higher, but at other times could have a deflationary effect.
“We at the ECB would agree that there should be more weight on housing – but there is a difficulty and this has been looked at several times before,” he said. “I do not want to pre-empt the review by saying that that is what we are necessarily going to conclude. It is a real issue and we have to be practical about it.”
The central bank has pledged to continue QE and keep interest rates at present or lower levels until both headline inflation and underlying pressures show that the goal is close. Economists surveyed by Bloomberg say bond-buying will continue until at least the end of next year and rates won’t rise until 2022.
While some ECB policy makers have raised concerns that financial stability risks are rising, such as enfeebled banks and escalating asset prices, Lane signaled that he’s convinced of the need to push on.
“In the end, I share the view of many that the most important influence on expectations is actual inflation,” he said. “Unless we get actual inflation up, we can talk as much as we like and communicate as much as we like, but in the absence of evidence that inflation is moving up, then many people will ignore the central bank’s communication.”
--With assistance from Piotr Skolimowski.
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To contact the editors responsible for this story: Paul Gordon at email@example.com, David Goodman
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