ECB’s Lane: Prolonged conflict could lead to a substantial spike in inflation
European Central Bank (ECB) chief economist Philip Lane said on Tuesday that a prolonged conflict could lead to a substantial spike in inflation. At the same time, it could also cause a sharp drop in output in the euro area.
Key quotes
Prolonged conflict could lead to a substantial spike in inflation.
At the same time, it could also cause a sharp drop in output in the euro area.
Directionally, a jump in energy prices puts upward pressure on inflation especially in the near-term.
The magnitude of the shock heavily depends on the breadth and duration of the conflict.
Barring any major shocks, euro area economy is growing in the neighbourhood of its potential.
Even when taking out any energy price volatility, inflation is still running above the 2% medium-term target.
This is not an environment where I see an argument in favour of taking a bit of risk on inflation.
Market reaction
At the time of writing, EUR/USD is trading 0.16% lower on the day at 1.1670.
ECB FAQs
The European Central Bank (ECB) in Frankfurt, Germany, is the reserve bank for the Eurozone. The ECB sets interest rates and manages monetary policy for the region. The ECB primary mandate is to maintain price stability, which means keeping inflation at around 2%. Its primary tool for achieving this is by raising or lowering interest rates. Relatively high interest rates will usually result in a stronger Euro and vice versa. The ECB Governing Council makes monetary policy decisions at meetings held eight times a year. Decisions are made by heads of the Eurozone national banks and six permanent members, including the President of the ECB, Christine Lagarde.
In extreme situations, the European Central Bank can enact a policy tool called Quantitative Easing. QE is the process by which the ECB prints Euros and uses them to buy assets – usually government or corporate bonds – from banks and other financial institutions. QE usually results in a weaker Euro. QE is a last resort when simply lowering interest rates is unlikely to achieve the objective of price stability. The ECB used it during the Great Financial Crisis in 2009-11, in 2015 when inflation remained stubbornly low, as well as during the covid pandemic.
Quantitative tightening (QT) is the reverse of QE. It is undertaken after QE when an economic recovery is underway and inflation starts rising. Whilst in QE the European Central Bank (ECB) purchases government and corporate bonds from financial institutions to provide them with liquidity, in QT the ECB stops buying more bonds, and stops reinvesting the principal maturing on the bonds it already holds. It is usually positive (or bullish) for the Euro.
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