Europe's interest rates to stay high as long as needed to defeat inflation, central bank chief says

European Central Bank President Christine Lagarde warned on Tuesday that inflation is holding its grip on the economy and underlined that the bank intends to raise rates high enough to “break this persistence”.

Lagarde acknowledged that inflation has fallen from all-time highs last year as energy prices plunged and the bank rolled out a rapid series of rate increases, which are meant to fight price spikes by making it more expensive for consumers and businesses to borrow and spend.

“We are seeing a decline in the inflation rate as the shocks that originally drove up inflation wane and our monetary policy actions are transmitted to the economy,” she said in a speech opening the ECB’s annual policy conference in Sintra, Portugal. “But the pass-through of those shocks is still ongoing, making the decline in inflation slower and the inflation process more persistent,” Lagarde added.

Businesses initially passed on their rising costs by charging customers higher prices, a phase that is starting to wane. Now, with unemployment at record lows, workers are demanding higher wages to make up for lost purchasing power — threatening to keep pushing up inflation in a wage-price spiral that the bank must prevent.

Workers, Lagarde said, “have so far lost out from the inflation shock, seeing large real wage declines, which is triggering a sustained wage catch-up process as they try to recover their losses. This is pushing up other measures of underlying inflation.”

She said the ECB needs “to address this dynamic decisively” by raising rates as far as needed. The bank would discourage “expectations of a too-rapid policy reversal” and keep rates high for as long as needed, Lagarde said.

Inflation in the 20 countries that use the euro currency came in at 6.1 per cent in May, heading down from a peak of 10.6 per cent in October after declines in energy prices that surged after Russia’s invasion of Ukraine.

But inflation is well above the bank’s target of 2 per cent considered best for the economy. And core inflation — which excludes volatile food and fuel prices — is stubbornly high at 5.3 per cent. New inflation figures are to be published on Friday, with analysts at Deutsche Bank foreseeing another decline in overall inflation to 5.8 per cent.

The Bank of England surprised with a large half-point hike last week.