Expert View: ECB takes its foot off the gas

"The balance of risks to future price stability has gradually been moving towards the upside." With this argument the European Central Bank (ECB) announced a 0.5 per cent rate rise to 3 per cent at the start of this month - the first tightening in its short history. Is this going to dampen eurozone recovery or strengthen the long-term outlook?

After the lowering of the key refinancing rate to 2.5 per cent in April, and with inflation still below its 2 per cent threshold, the ECB's decision reflects a reassertion of its price-stability mandate now that Europe's cyclical economic pickup is under way. Even more than for the US Federal Reserve, price stability is the ECB's primary mandate: economic growth is subsidiary.

While the rate rise may be followed by more moderate tightening next year as extra evidence of inflation and spending emerges, no dramatic shift up is in sight. Eurozone interest rates will remain lower than in the US and the UK next year.

Eurozone annual growth in consumer prices was 1.4 per cent in October against 0.8 per cent in February. Other indicators suggest the best news on inflation is past already, with surveys on price expectations moving up sharply, and oil price rises and the euro's depreciation continuing their influence. The ECB's move will certainly help keep these early indications of inflationary pressure under control, and the outlook remains quite reassuring.

Over the past few months, signs of cyclical rebound in Europe have mounted, with rising investment and relatively robust private consumption. Exports, which had slumped during the Asian crisis, have started to strengthen. This recovery will not be short-circuited by the tightening. Interest rates are still low and the refinancing rate is still 2.5 per cent below the UK base rate, with inflation at a similar level.

Positive sentiment among consumers and businesses is not going to be undercut either - recovery in world demand and a gradually improving continental labour market bode well. At any rate, central bankers are trying to assess the level of interest rate that sustains non-inflationary growth. So any near-term negative impact is more than compensated for by a longer-term non-inflationary growth picture.

A rosy scenario then? Well, probably there are still some risks. Eurozone recovery is expected to boost productivity and cut labour costs. There seems to be no risk of a wage-price spiral, but upcoming wage negotiations in Europe - not least the bellwether round at IG Metall - are key.

The heightened credibility of the ECB should contribute to lower wage settlements. But in the highly regulated European labour market, and with complex socio-political relationships between centre-left ruling coalitions and unions, responsibility may not prevail. Unions could anticipate an inflation risk even higher than the ECB's and go for higher nominal wages instead of focusing on having real wages safeguarded by the Bank.

It is unclear whether the rates rise will have a positive impact on wages, or whether it would have been better to hold off raising rates while sending clear signals about the risk of a substantial tightening under strong wage pressures. Past strategy, at least in Germany, is more the latter, with the emphasis on social cohesion. Indeed, "keeping great vigilance" may be more effective than the pre-emptive strike the Bank has made.

The assumption that oil prices will stabilise around current levels may also be challenged. Opec's discipline on production cuts could become self-reinforcing. The firmer prices get, the less incentive Opec countries have to cheat, so amplifying the supply shortage despite rising demand. If combined with the continuing weakness of the euro, this may eventually generate the much-feared "second-round" effects on prices that could lead to a larger monetary tightening.

Although enhanced competition, deregulation and liberalisation of the eurozone economy are having a positive impact on prices, there may still be enough rigidities to stop the advantages triggered by monetary union from fully showing themselves.

But the most likely economic scenario confirms what Wim Duisenberg, the ECB president, said a month ago to the EU parliamentary committee: "Raising interest rates in a certain situation might be more akin to lifting your foot from the [accelerator] pedal a little bit than to braking the car ... in that way going slower, as going forward is what we all want to do."

n Lorenzo Codogno is head of European economics and interest rate research at the Bank of America in London.

people Emma Watson addresses celebrity nude photo leak
Katie Hopkins appearing on 'This Morning' after she purposefully put on 4 stone.
peopleKatie Hopkins breaks down in tears over weight gain challenge
Boris Johnson may be manoeuvring to succeed David Cameron
Band was due to resume touring this month
people'It can last and it's terrifying'
In this photo illustration a school student eats a hamburger as part of his lunch which was brought from a fast food shop near his school, on October 5, 2005 in London, England. The British government has announced plans to remove junk food from school lunches. From September 2006, food that is high in fat, sugar or salt will be banned from meals and removed from vending machines in schools across England. The move comes in response to a campaign by celebrity TV chef Jamie Oliver to improve school meals.
Arts and Entertainment
Life and Style
fashionModel of the moment shoots for first time with catwalk veteran
Life and Style
fashionAngelina Jolie's wedding dressed revealed
ebooksAn unforgettable anthology of contemporary reportage
Tom Cleverley
Loan move comes 17 hours after close of transfer window
Alexis Sanchez, Radamel Falcao, Diego Costa and Mario Balotelli
footballRadamel Falcao and Diego Costa head record £835m influx
Arts and Entertainment
Madame Vastra and Jenny Flint kiss in Doctor Who episode 'Deep Breath'
indybest 9 best steam generator irons
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Executive Assistant/Events Coordinator - Old Street, London

£35000 - £38000 per annum + benefits: Ashdown Group: Executive Assistant/Event...

HR Generalist (standalone) - Tunbridge Wells - £32,000

£30000 - £32000 per annum: Ashdown Group: HR Generalist (standalone) - Tunbrid...

Derivatives Risk Commodities Business Analyst /Market Risk

£600 - £800 per day: Harrington Starr: Derivatives Risk Commodities Business A...

Power & Gas Business Analyst / Subject Matter Expert - Contract

£600 - £800 per day: Harrington Starr: Power & Gas Business Analyst/Subject Ma...

Day In a Page

'I’ll tell you what I would not serve - lamb and potatoes': US ambassador hits out at stodgy British food served at diplomatic dinners

'I’ll tell you what I would not serve - lamb and potatoes'

US ambassador hits out at stodgy British food
Radio Times female powerlist: A 'revolution' in TV gender roles

A 'revolution' in TV gender roles

Inside the Radio Times female powerlist
Endgame: James Frey's literary treasure hunt

James Frey's literary treasure hunt

Riddling trilogy could net you $3m
Fitbit: Because the tingle feels so good

Fitbit: Because the tingle feels so good

What David Sedaris learnt about the world from his fitness tracker
Saudis risk new Muslim division with proposal to move Mohamed’s tomb

Saudis risk new Muslim division with proposal to move Mohamed’s tomb

Second-holiest site in Islam attracts millions of pilgrims each year
Alexander Fury: The designer names to look for at fashion week this season

The big names to look for this fashion week

This week, designers begin to show their spring 2015 collections in New York
Will Self: 'I like Orwell's writing as much as the next talented mediocrity'

'I like Orwell's writing as much as the next talented mediocrity'

Will Self takes aim at Orwell's rules for writing plain English
Meet Afghanistan's middle-class paint-ballers

Meet Afghanistan's middle-class paint-ballers

Toy guns proving a popular diversion in a country flooded with the real thing
Al Pacino wows Venice

Al Pacino wows Venice

Ham among the brilliance as actor premieres two films at festival
Neil Lawson Baker interview: ‘I’ve gained so much from art. It’s only right to give something back’.

Neil Lawson Baker interview

‘I’ve gained so much from art. It’s only right to give something back’.
The other Mugabe who is lining up for the Zimbabwean presidency

The other Mugabe who is lining up for the Zimbabwean presidency

Wife of President Robert Mugabe appears to have her sights set on succeeding her husband
The model of a gadget launch: Cultivate an atmosphere of mystery and excitement to sell stuff people didn't realise they needed

The model for a gadget launch

Cultivate an atmosphere of mystery and excitement to sell stuff people didn't realise they needed
Alice Roberts: She's done pretty well, for a boffin without a beard

She's done pretty well, for a boffin without a beard

Alice Roberts talks about her new book on evolution - and why her early TV work drew flak from (mostly male) colleagues
Get well soon, Joan Rivers - an inspiration, whether she likes it or not

Get well soon, Joan Rivers

She is awful. But she's also wonderful, not in spite of but because of the fact she's forever saying appalling things, argues Ellen E Jones
Doctor Who Into the Dalek review: A classic sci-fi adventure with all the spectacle of a blockbuster

A fresh take on an old foe

Doctor Who Into the Dalek more than compensated for last week's nonsensical offering