ECB Governing Council member Nagle: If energy prices continue to rise, interest rates may need to be raised to a moderately restrictive level

The Zhitong Finance App learned that ECB Management Committee member and Bundesbank President Joachim Nagel said that if energy prices continue to be high, the ECB may have to raise interest rates to a level that inhibits economic growth. “If we face high energy prices like today for a long time, I cannot rule out the possibility that we will have to enter a moderately restrictive range of monetary policy,” Nagle said on Tuesday. Although he added at the same time, it is still too early to judge this.

It is worth mentioning that there are differences of opinion within the ECB regarding the level of neutral interest rates. ECB chief economist Philip Lane said earlier this year that the neutral interest rate could be as high as 2.5% — this is the ECB's current interest rate level. However, Bank of Ireland Governor Gabriel Mahloof believes that only interest rates above 2.75% will enter the restricted range.

Nagel also said, “What I am or are worried about is that this may have a second round of inflation effects.” He was referring to upcoming wage negotiations in some countries, including Germany. “We all know that if this continues for longer and longer, we will see some second-round effects.” He said that's why “we have to be alert” and “that's what we're saying in this situation. And I can assure you, we are on the alert”.

Given the current pressure on the bond market, when asked if it is possible to use the ECB's so-called transmission protection tool (TPI), Nagle said that this tool can only be launched if there is a problem with the transmission mechanism of monetary policy. “This has nothing to do with the fiscal challenges facing one or another country in the Eurosystem,” he said. Last week, the yield premium on French 10-year government bonds over German treasury bonds surpassed 100 basis points, the first time in 14 years.

Expectations of ECB rate hikes are heating up, and inflation is still a “nail in the eye”

The ECB raised interest rates by 25 basis points on September 10, raising the deposit mechanism interest rate to 2.50%, in line with market expectations. This is the second time the ECB has raised interest rates during the year. The ECB Governing Council emphasized in its policy statement that the Middle East conflict continues to bring inflationary pressure, and the Eurozone inflation rate is expected to rise significantly by 2% to the target level within a “long period of time.” Lagarde further clarified at the press conference that “longer period” means “continuing until at least the first half of 2027,” and overall inflation is expected to return to near the target level around the end of 2027.

Meanwhile, the ECB's latest forecast shows that the average overall inflation forecast for 2026 is 3.0%, which is the same as the June forecast; 2.5% in 2027 and 2.1% in 2028, which is higher than the previous forecast for the next two years. Excluding energy and food, core inflation expectations are also high. The three-year forecasts are 2.5%, 2.6%, and 2.3%, respectively, which are higher than the 2% policy target. Some analysts believe that the revised inflation forecast combined with data-dependent policy positions provided a basis for further tightening by the ECB. The market anticipates that the ECB may raise interest rates up to three more times in the current cycle of interest rate hikes.

Furthermore, according to the ECB's monthly survey released on Friday, Eurozone households' inflation expectations rose across the board in August — adding another layer of evidence to austerity bets that were heating up after the second rate hike on September 10.

According to the data, the median one-year inflation forecast rose to 3.0% from 2.9% in July, the median three-year inflation forecast rose from 2.7% to 2.9%, and the five-year median inflation forecast rose from 2.4% to 2.5%. Among them, the three-year median inflation forecast index has a higher reference value for monetary policy formulation. All three periods were higher than the ECB's 2% target, which means that “inflation returns to target” is not really believed within the visible time frame, even based on the judgment of the household sector.

In the ECB's policy response function, inflation expectations are not a decoration. The central bank made it clear in its statement after the September resolution that policymakers are carefully studying expectations — because they will shape future wage negotiations and companies' pricing behavior; the reason why the three-year indicator is particularly valued is because it is closer to the length of the wage contract pricing cycle.

Lane warned this week that a new round of high energy prices means that inflation in the Eurozone will stay high longer than the ECB initially anticipated. He said, “We are seeing a second wave of price increases, not only in oil, but also in natural gas. We believe this round of energy price increases will make inflation higher and more durable, and then fall back to our target starting in mid-2027.”

ECB Governing Council member and Slovak Central Bank President Peter Kazimir said that if necessary, the ECB will not hesitate to further raise interest rates, but it will take time to determine the next steps. He said that ECB officials first need to assess whether the indirect effects of the sharp rise in energy costs caused by the war are developing as expected, and “whether demand and labor market conditions are strong enough to produce a second round of effects.”

ECB President Lagarde's statement appeared more cautious. Lagarde said on Friday that a jump in energy prices will not automatically translate into monetary contraction. She stated, “Interest rates will not change at the same time as energy prices. Because obviously, energy prices and their impact on prices will also affect other factors, especially growth and consumption. We will take all of these factors into account; the synchronous linkage mechanism is not a mechanism that actually applies.”