Persistent inflation fuels some of the ECB’s worst fears

By Balazs Koranyi

FRANKFURT, March 2 (Reuters) – A surprising rebound in core inflation in the 20 eurozone countries has bolstered bets on further rate hikes by the European Central Bank in the spring, as policymakers fear growth could prices is even more persistent than previously thought.

Headline inflation eased slightly to 8.5% last month from 8.6% in January, data showed Thursday. But almost all of the decline was due to lower energy costs, while prices for most other items – including food, services and durable goods – rose again, confirming the worst fears of some ECB monetary policymakers.

The rise in core inflation (from 5.3% to 5.6%) reinforces the already abundant evidence that past price increases are reverberating throughout the economy, notably through wages. This will make inflation harder to defeat and will require a more determined tightening of monetary policy.

The ECB has already announced a half-percentage-point rate hike for March 16, and ECB President Christine Lagarde confirmed it on Thursday, quashing market rumors of a bigger hike and drawing attention to the next ECB meeting in May.

“We have every reason to believe there will be another 50 basis point hike at our next meeting in March,” Lagarde said. “I have no reason to believe it won’t.”

Markets are also expecting another 50 basis point hike on May 4, and the accounts from the ECB’s February meeting, released on Thursday, did little to challenge those bets.

“Underlying inflation and other measures are likely to be more rigid, with little sign of stabilization so far,” the ECB said in the February 1-2 meeting accounts.

“For official Board of Governors interest rates to enter restrictive territory, further increases are needed.”

A key concern for currency leaders is that labor markets are so tight that wage growth, which is expected to be between 5% and 6% this year, will fuel price pressures.

MORE INCREASES IN TYPES

Unemployment held steady at 6.7% in January, just above a historic low, while employment is at record highs and many businesses, especially in services, are complaining of a labor shortage.

Labor market concerns will likely be exacerbated by better-than-expected economic growth, which will also put upward pressure on wages.

“All of this leads us to change our view of the ECB for the second time in a week,” said Greg Fuzesi, economist at JP Morgan. “Specifically, we raised (the expected rate hike in) May by 25 basis points to 50 basis points, bringing our terminal rate forecast to 3.75% in June.”

Market bets on ECB rates have risen so rapidly that investors are now pricing in rate hikes 50 basis points higher than a month ago, with rates peaking just above 4% at the start. of year.

The recent inflation results are broadly in line with recent warnings from Conservative policymakers, who appear to have a clear majority on the 26-member Board of Governors.

ECB Council member Isabel Schnabel has long argued that inflation could be more persistent than expected, while Bundesbank President Joachim Nagel said this week that the recent drop in energy prices n The medium-term outlook had not improved, so the ECB may have to opt for another big rate hike in May.

In addition to raising rates, the ECB is fighting inflation by absorbing some of the 7 trillion euros in liquidity it injected into the financial system during nearly a decade of aggressive monetary issuance.

To do this, it is not rolling over long-term loans to banks and, starting this month, it is not replacing some of the bonds it has purchased as they mature.

Schnabel said on Thursday there was still too much cash circulating in the banking system, paving the way for further quantitative tightening (QT) in the coming months.

“Our current estimates suggest that the amount of central bank reserves currently held by the banking industry far exceeds the level needed to control short-term market rates,” he said in a speech.

(Additional reporting by Francesci Canepa; Editing by Hugh Lawson and Catherine Evans; Editing in Spanish by José Muñoz in the Gdansk newsroom)