European Central Bank Chief Economist Philip Lane said on Wednesday that the bank may need to lift interest rates in June to prevent higher fuel prices linked to the Iran conflict from transmitting into wages and broader inflation.
Lane set out the case for a potential June tightening even though some officials recognise the move could slow economic activity across the energy-importing euro zone. He said a rate increase at that meeting is seen by some policymakers as the initial step in what could become a sequence of rate rises.
Addressing an audience in London, Lane said policy-makers should weigh the nature of the shock driving prices. "The optimal response might be smaller for an exogenous supply disruption than for a demand shock but there are several reasons why an active response may be required," he said.
He added that the Iran conflict is occurring against a backdrop of already elevated inflation. Following the COVID-19 pandemic and Russia's invasion of Ukraine, firms and consumers are likely to be more sensitive to price movements, Lane noted, which raises the risk that an increase in fuel costs could feed through into wage-setting and general price-setting behaviour.
Those dynamics underlie why some policymakers are prepared to consider monetary tightening even though higher interest rates have the potential to weigh on growth in economies that import energy. Lane's remarks underline the trade-offs confronting the ECB: acting to prevent a wage-price spiral versus avoiding additional headwinds to activity.
Context and implications
Lane's comments make clear that the ECB is monitoring the pass-through risk from energy prices to wages and broader inflation. The view that a June rate rise could be the first of multiple hikes reflects concern among some policymakers that in the current inflationary environment a measured but active response may be needed to anchor inflation expectations.
At the same time, the potential negative impact on growth in energy-importing countries remains a central consideration for the bank.