Inflation remains high! ECB Governing Council member warns: Another rate hike may be necessary, but timing remains uncertain

According to Zhitong Finance APP, Pierre Wunsch, a member of the European Central Bank's Governing Council and Governor of the National Bank of Belgium, said that the European Central Bank may need to raise interest rates further. In an interview, he stated: “We may have to raise interest rates again. But I’m not betting on it now, because there’s too much uncertainty regarding energy, and possibly also with artificial intelligence (AI).”

Wunsch declined to reveal whether this meant the ECB would act later this month or raise rates at its final decision of the year. He said: “Ultimately, whether it’s October or December doesn’t really matter. Current market pricing shows that we will have to take further action. So, this looks like a reasonable baseline scenario, but again, we are in a highly uncertain world.”

The ECB is currently discussing whether to raise rates further after two hikes this year in order to rein in inflation that is nearing 4%. Economists expect the ECB to implement its final rate hike in December, bringing the deposit rate to 2.75%. The market estimates that after reaching this level, rates will begin to constrain economic activity.

Eurozone inflation rises to a three-year high

According to data from Eurostat, eurozone inflation rose to 3.8% in September, up from 3.2% in August; energy prices surged 18.8% year-on-year, making them a significant factor in driving up inflation. In response to rising energy prices, governments in several European countries have taken measures such as lowering fuel taxes, intervening in energy prices, and providing subsidies to residents and businesses. However, subsidies can only alleviate the short-term burden and can't address the fundamental causes of rising energy prices.

Wunsch said: “Inflation is too high.” He added, “Market expectations have changed,” and now “no longer expect a rate hike in October.” “We have said we will rely on data and make decisions meeting by meeting. We may receive some new data, so I will not rule out any possibilities.”

The surge in energy prices driven by the Middle East conflict is putting pressure on eurozone inflation. However, policymakers emphasize that they have not yet seen second-round effects such as wage increases. Several officials, including ECB chief economist Philip Lane, have stated that “measured” policy responses should be sufficient to restore price stability.

In another speech, ECB President Christine Lagarde said that the high inflation in the eurozone driven by high energy prices has not yet spread to the broader economy. She said that ECB officials are assessing “how much indirect impact is transmitting through the economy and considering how best to anticipate these effects should second-round factors begin to manifest.” She stated: “Currently, we haven’t seen any such phenomenon, but we must be extremely cautious to ensure we can spot even the smallest signs and indicators of these secondary effects.”

Despite an unexpectedly resilient performance by the eurozone economy, further escalation of Middle East tensions and high bond yields remain key risks. Lagarde warned that the surge in bond yields would have a greater drag on economic activity than previously expected. Banque de France Governor François Villeroy de Galhau expressed a similar view on Wednesday. He said: “The rise in yields is putting pressure on financial conditions.” “This could impact demand and may lead us to adopt a more moderate response to the inflation shock, because higher yields themselves are already playing a role.”

Villeroy took a stance similar to Lagarde’s on inflation. He said that the ECB expects “indirect and second-round effects to remain contained,” and that the core price indicators in the eurozone would only “accelerate moderately.” He stated: “What we are seeing, and I think this is an important factor, is that both companies and households have well-anchored medium-term inflation expectations.” He added that the market “has already fully understood” the ECB’s reaction function.

Additionally, the substantial rise in the French government's financing costs has refocused market attention on the ECB’s crisis response tools, including the so-called “Transmission Protection Instrument” (TPI) designed in 2022. This tool aims to curb unreasonable market volatility and allows the ECB to buy unlimited amounts of government bonds.

Wunsch said: “I don’t want to speculate on whether or when the ECB might intervene. We have this tool, as you mentioned, the TPI. There is some gray area here, and I will not speculate on all possible gray areas. But the tool does exist, and if developments become unreasonable, we have the means to respond.”

However, the current situation does not seem likely to meet the conditions for deploying this tool, as investors are at least partly reacting to France’s political deadlock over budget issues. Villeroy has also warned that the ECB is not there to “manage the fiscal problems of individual countries.”

Wunsch said: “To some extent, there is some market pressure that is even helpful, because governments can say to their voters, ‘Look, if we don’t do this, we will have to face higher interest costs on debt.’” He added: “But we know that politically, reducing deficits is not easy, and that’s the reality.”