FRANKFURT (Reuters) -Shifts in the risk profile of euro zone inflation will impact ECB policy decisions and a rise in the chance of undershooting the target would firm the case for a ‘slight’ reduction in borrowing costs, ECB chief economist Philip Lane said on Monday.
The ECB has cut interest rates by 2 full percentage points in the year to June but has been on hold ever since and policymakers are now debating whether to go even lower or level off at the current 2% rate since inflation is now at target.
“Shifts in the risk distribution will also matter for our rate decisions: an increase in the likelihood or intensity of downside risk factors would strengthen the case that a slightly-lower policy rate might better protect the medium-term inflation target,” Lane said in a speech in Frankfurt.
“Alternatively, an increase in the likelihood or intensity of upside risk factors would indicate that maintaining the current policy rate would be appropriate in the near term,” he added.
Financial markets see almost no chance of another rate cut this year and comments from ECB Vice President Luis de Guindos only firmed those expectations.
“We could say that risks for inflation are balanced and that our projections, which showed that the price stability objective can be secured in some way, are being fulfilled to some degree,” de Guindos told an event in Madrid.
“We consider the current level (of interest rates) to be appropriate based on recent inflation trends,” he said.
But the jury is still out. Some policymakers fear that the full extent of U.S. tariffs is yet to be felt and a strong euro will hurt exporters while pulling overall inflation below the ECB’s 2% target.
Lane noted that the stronger euro has a multi-year impact on both activity and inflation, and the underlying reasons for the currency movement impact the extent of the price shock.
“These effects will be larger than the average if euro appreciation is more due to external factors, such as weakness in main trading partners or portfolio rebalancing due to an increase in the risk premium in overseas financial markets,” he said.
The euro is up 13% on the dollar since the start of the year as investors reduced their dollar holdings due to concerns about erratic U.S. economic policy.
(Reporting by Balazs Koranyi; Editing by Kirsten Donovan, Alexandra Hudson)
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