Risk markets underestimate inflation, says ECB’s Schnabel

Bloomberg

One of the European Central Bank’s (ECB) most senior officials said that investors risk underestimating the persistence of inflation, and the response needed to bring it under control.
“We are still far away from claiming victory,” Executive Board member Isabel Schnabel said in an interview with Bloomberg, citing the strength of underlying price pressures and faster wage increases. The economy’s reaction to interest-rate increases may prove weaker than in prior episodes, and if that transpires, “we may have to act more forcefully.”
The central bank has all but promised another half-point step in March, a hawkish stance that chimes with the US Federal Reserve’s own approach to continue steady hikes.
Questioned if economists and investors are justified in assuming the ECB will halt tightening at a rate of 3.5%, Schnabel signaled that may be too optimistic.
“Markets are priced for perfection,” she said. “They assume inflation is going to come down very quickly towards 2% and it is going to stay there, while the economy will do just fine. That would be a very good outcome, but there is a risk that inflation proves to be more persistent than is currently priced by financial markets.”
While their short-term inflation measures have retrenched enormously from last year’s energy-induced spike, longer-term metrics remain elevated at about 2.4% — above the ECB’s 2% goal. Traders bolstered hike bets after Schnabel’s remarks, fully pricing a 3.75% peak in the deposit rate by the end of October for the first time.
Germany’s 10-year yield, meanwhile, jumped as much as 9 basis points to 2.57% — near the highest level since 2011.
Schnabel, who’s the ECB’s official in charge of markets and one of the more hawkish members of the Executive Board, suggested that policymakers are unlikely to judge the inflation outlook as satisfactory when releasing new projections in March.
A 50 basis-point hike next month is “necessary under virtually all plausible scenarios,” she said, insisting that “there is no inconsistency between our principle of data-dependency and these intentions because it’s very unlikely that the incoming data is going to put this intention into question.”
While headline inflation across the 20-nation euro zone has eased faster than expected along with energy costs, gauges that strip out volatile components are still clinging to record highs.
“A broad disinflation process has not even started,” Schnabel said. Wages are therefore a concern. She cited forecasts for pay to rise as much as 5% in the coming years, too high compared with the ECB’s 2% inflation target.
“Wage growth has picked up substantially,” Schnabel said. “Given a longer duration of wage contracts compared to the US and a more centralised bargaining process, one could expect wage growth in the euro area to be more persistent.”