Monetary Policy in 2023 and Beyond

Speaking at the Institute of International and European Affairs, the Governor of the Central Bank of Ireland, Gabriel Makhlouf, gives his views on inflation and monetary policy:

• Inflation of 9-10% in Ireland and the Eurozone is unacceptably high.
• High inflation is eroding real incomes, threatening resilience and economic stability.
• The priority for the ECB is to return inflation sustainably to its 2% target.

On the outlook for monetary policy the Governor says that:

• “To continue on our path to bring inflation back to our 2% target, I see a 50 basis point increase in interest rates as the minimum needed at our December meeting.
• “We have to be open to policy rates moving into restrictive territory for a period.  It is premature to be talking about the end-point for policy rates amid the prevailing levels of uncertainty.
• “The justification for the expansion of the balance sheet – too low inflation and the risk of deflation – has ended, and it is time to look at reducing its size.”

The Governor talked about how two-thirds of headline inflation in the euro area is due to energy (3.8% of 10% inflation in November) and food (2.8%), far above its historical share of around 40%.   But not all inflation is due to food and energy price increases.  Non-energy components of domestic inflation, accounting for over one-third of spending, are also very high by historical standards, driven by strong post-pandemic demand meeting constrained supply.

The labour market remains tight, despite the weakening in the growth outlook. There is some evidence of second round effects from current inflation into wages. But wage growth of 4 to 5% still lags inflation.   

Inflation expectations, have moved up alongside headline inflation.  We need to watch closely for warning signs of inflation expectations moving away from our 2% target.  Were expectations to become ‘dis-anchored’ in this way, it would make the task of sustainably returning inflation to our 2% target far more difficult, and preventing it is one of the reasons for the forceful monetary policy response.

Highlighting the already significant actions by central banks globally, the Governor said that “The ECB has raised interest rates at an unprecedented pace in order to bring supply and demand back into balance, and return inflation sustainably to our 2% target.  The main ECB policy rate has increased from -0.5% in June to 1.5% in October, with further increases likely.”