Core inflation worries the ECB

He European Central Bank (ECB) It is concerned about core inflation, which devalues ​​energy and food because they are more volatile, chief economist Philip Lane said on a podcast for the company.

Lane explained in the podcast, which aired on the ECB’s website this Friday, that it makes sense to take core inflation into account in order to bring headline inflation towards the 2% medium-term target.

Wages and benefits drive core inflation

According to Lane, the ECB is now finding that wage increases and corporate profits are driving core inflation in the euro area.

The company cannot tolerate that inflation, which started to rise in mid-2021 due to the recovery from the pandemic, shortages and rising energy costs, is too high and must act, its chief economist added.

Core inflation is now a better predictor of headline inflation going forward over the medium term, say some ECB economists in an article in next’s economic bulletin, due out this Friday.

“The present value of core inflation measures provides, on average, a better medium-term forecast of future headline inflation than the present value of headline inflation itself,” several ECB economists say in the article.

HIGH LEVELS OF UNCERTAINTY

They also recommend complementing core inflation measurements with monitoring of factors that can contribute to inflationary pressures in the euro area, such as data on wages, corporate earnings and inflation expectations.

Core inflation is much higher than before 2022, suggesting “there is a high level of uncertainty,” according to ECB economists.

The decline in energy prices has reduced the external factor that has been driving up core inflation, but internal factors such as rising wages and corporate earnings are now putting upward pressure in the euro area.

But Fabio Panetta, a member of the ECB’s Executive Committee and from November the next Bank of Italy governor replacing Ignazio Visco, said in a speech in Italy on Thursday that “core inflation is not a leading indicator of inflation”.

“Although core inflation is still elevated and is expected to remain at current levels throughout the summer, empirical evidence suggests that it is a lagging indicator of inflation and not a leading indicator,” Panetta said.

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“Looking at core inflation today doesn’t tell us much about where headline inflation will be over the medium term,” Panetta said.

He also noted that interest rates on corporate and household loans are at their highest levels since late 2008 and summer 2012, respectively.

Demand for credit fell to its lowest level in two decades in the second quarter of this year.

For this reason, Panetta believes that not only the maximum level to which the ECB will raise interest rates in this bullish cycle is important, but also how long it will keep them at that level.

The ECB will use the economic data to decide what to do with interest rates

Since July last year, the ECB has hiked interest rates from 0% to 4.25% nine times in a row in a bid to curb inflation.

Their president, Christine Lagarde, said last week that they could raise or keep the cash price again in September.

That 4.25% rate, at which the ECB lends money to banks weekly, is now the highest since July 2008, when it was the minimum rate at which banks bid for liquidity.

At the time, the ECB was still lending them at a variable rate through an auction process, so banks had to bid for the amount of liquidity they wanted to receive and the interest rate to be paid for it.

Due to the severe lack of liquidity during the global financial crisis, the ECB fixed these auctions at a fixed rate and lent them as much as they asked at that rate.

The deposit rate, at which the ECB pays banks excess reserves for a day, is now 3.75%, the highest level in more than 20 years.

Since banks now have a lot of liquidity because it was provided by the ECB, the interest that the ECB pays on the reserves that banks hold in their deposit facility is now the ECB’s main monetary policy tool.

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