ECB’s chief economist cautions markets not to anticipate rate cuts in the next two years

Philip Lane, Chief Economist of the European Central Bank, cautioned markets on Tuesday against anticipating interest rate cuts in the next two years.

In a series of increases since July 2022, the European Central Bank raised its main rate by 25 basis points to 3.5% earlier this month, aiming to address the record-high inflation in the euro zone.

In May, headline inflation in the euro zone was reported at an annual rate of 6.1%, a decrease from the previous month’s 7%. However, core inflation, which excludes volatile food and energy prices, stood at 5.3% year on year, remaining significantly above the European Central Bank’s target of 2%.

During an interview with CNBC’s Annette Weisbach at the Sintra central bank meeting in Portugal, the former governor of the Central Bank of Ireland stated that the euro zone economy is currently undergoing an “adjustment phase.” He highlighted that as higher interest rates take effect, wages are striving to catch up with rising prices.

Lane suggested that the market should reflect on the timing and pace of reversing restrictive policies.

Lane stated that it will take a couple of years to return to the 2% target and that although progress will be made this year, it will not rapidly drop to 2% within a few months.

Similar sentiments were expressed by ECB President Christine Lagarde, who emphasized that while the central bank had made significant progress, it was not yet in a position to declare victory.

Since July 2022, the ECB has implemented a total of 400 basis points worth of rate hikes. While markets anticipate an additional 25 basis-point increase next month and are considering another hike in September, there are speculations among economists that the ECB might need to reverse its monetary tightening due to the potential economic slowdown caused by higher rates in the euro zone.

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Earlier this month, the U.S. Federal Reserve decided to pause its rate hiking cycle and maintained its target rate unchanged. However, it expressed a hawkish stance by indicating the possibility of two more rate increases later in the year.

Lane recommended that policymakers should remain steadfast and maintain a tight grip on monetary conditions for an extended period.

He emphasized the importance of a prolonged phase during which interest rates should remain at a restrictive level to ensure the avoidance of any unforeseen disruptions that could deviate us from the 2% target. Lane underlined the crucial aspect of maintaining the enduring nature of these restrictive measures.

“As I survey the foreseeable future over the next few years, I do not anticipate swift reductions in interest rates. Therefore, I believe it would be inappropriate to factor in expectations of rapid rate cuts.”

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