ECB’s chief economist warns of too-low inflation if rates stay high

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Inflation in the Eurozone could fall below the European Central Bank’s 2 per cent target if policymakers do not continue to cut interest rates, its chief economist Philip Lane has warned.

In an interview with Austrian daily Der Standard that was published on Monday, Lane said too little rather than too much inflation was now a risk that rate setters needed to take into account.

Borrowing costs should not “remain too high for too long” as growth could be so weak that “inflation could materially fall below target”, Lane said. He stressed that, like high rates of inflation, “that is also undesirable”.

Lane’s comments highlight a growing transatlantic gap in monetary policy as the Federal Reserve has switched to a more hawkish tone after inflation in the US picked up and strong job growth exceeded expectations.

Investors expect that the ECB will continue to make quarter-point reductions until borrowing costs reach about 2 per cent, after policymakers lowered the benchmark deposit rate in four steps from 4 to 3 per cent since June.

On Monday, Eurozone bond yields climbed to new multi-month highs following Friday’s strong US jobs data, reflecting expectations of higher global borrowing costs. Germany’s benchmark 10-year bond yield rose 3 basis points to 2.6 per cent, the highest since July.

Olli Rehn, governor of Finland’s central bank and member of the ECB’s governing council, told Bloomberg TV that further rate cuts in the euro area were necessary regardless of the Fed’s moves.

“[The ECB] is not the 13th federal district of the Federal Reserve System. We take decisions on the basis of our mandate, which is price stability in the euro area,” he said in an interview in Hong Kong.

Lane said the ECB needed to work out “the middle path of being neither too aggressive nor too cautious” in 2025 as persistently high inflation in the services sector, which continued to be at 4 per cent in December, continues to create risks for price stability.

“If interest rates fall too quickly, it will be difficult to bring services inflation under control,” Lane told Der Standard.

But the chief economist warned more clearly than in his previous public statements that weak growth was a threat to price stability.

“We also need to make sure that the economy does not grow too slowly, because then we face a new problem, which is that inflation might stabilise below the target,” he said.

Asked about a recent Financial Times survey in which many economists stated that the ECB has been too slow to cut interest rates, Lane said the central bank’s “primary focus” was on inflation rather than growth. However, he added that “growth is a basic driver of inflation dynamics”.

But he stressed that policymakers “do not see the kind of recessionary risk that would call for a dramatic acceleration in monetary easing”, a hint that larger, half-percentage point rate cuts that some economists hoped for are unlikely.