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ECB Nears Higher Interest Rates Limit to Combat Inflation

The European Central Bank (ECB) has made significant progress in raising interest rates to address inflation, according to French ECB policymaker Francois Villeroy de Galhau. However, he cautioned that additional rate increases should be limited in number and magnitude.

Francois Villeroy de Galhau
Francois Villeroy de Galhau

Justification for Tight Monetary Policy

Villeroy believes that the ECB is justified in maintaining a tight monetary policy, as there is no indication underlying inflation pressures are easing. He emphasized that most future economic impact is due to existing factors.

Expected Rate Hike in May

On May 4, the ECB is anticipated to raise interest rates for the seventh consecutive meeting. According to sources familiar with the discussions, policymakers are leaning towards a 25-basis-point hike instead of a larger 50 bps increase.

Limited Future Rate Hikes

Villeroy suggested that while a few more rate hikes might be necessary, they should be restricted in number and size. This indicates that he also supports a smaller rate increase.

Inflation Spreads Across Goods and Services

Initially triggered by energy and commodity prices, the current inflation crisis now affects all goods and services. Villeroy stated that neither inflation excluding energy and food, nor broader underlying indicators show clear signs of a changing trend.

Wage Catch-Up and Inflation

Considering the significant inflation spike over the past year, Villeroy noted that it is normal for wages to catch up with a slight delay. In France, the increase in average per capita wages is expected to surpass inflation this year before stabilizing in 2024.

Limited Price Increases in France

Unlike Germany and Spain, there is little evidence of companies in France pushing price increases to enhance profit margins, according to Villeroy.

France's Lower Inflation and Price Cap Measures

France has experienced lower inflation than other eurozone countries due to measures capping power and gas prices. The central bank estimates these measures will cost approximately 50 billion euros ($55 billion) over 2022-2023.

Phasing Out Price Cap Measures

Villeroy advised that these price cap measures should be gradually phased out over the next two years to avoid exacerbating inflation pressures in the medium term. Failure to do so could necessitate further monetary tightening from the central bank.