The European Central Bank must consider the “unprecedented” rise in house prices when assessing the high level of inflation and deciding how fast to tighten monetary policy, said one of its senior executives.
In the most “hawkish” comments by an ECB executive board member ahead of next month’s meeting at which it will decide when to withdraw its stimulus in response to record inflation in the eurozone, Isabel Schnabel told the Financial Times: “We cannot ignore this.”
“If this [rise in the costs of home ownership] were included, it would have a substantial effect on measured inflation, in particular on core inflation, where the weight of owner-occupied housing is larger,” she said. “It has to be part of our general considerations.”
She said including the costs of owning a home in the eurozone’s benchmark pricing figure would have added 0.6 percentage points to third-quarter core inflation of 1.4 per cent, excluding energy and food, taking it up to the ECB’s target of 2 per cent.
Unlike the US and UK, the eurozone does not include the costs of owning a house in its inflation data. But the ECB said last year it would start a multiyear process of incorporating owner-occupied housing costs into its targeted inflation measure. Until then it would consider price indicators such as an owner-occupied housing price index to show its effect.
Even without the recent 8.8 per cent annual surge in eurozone house prices, Schnabel said January’s rise in consumer inflation to a new high of 5.1 per cent and the fall of unemployment to an all-time low of 7 per cent meant “the risk of acting too late has increased and therefore we need a careful reassessment of the inflation outlook”.
When the ECB governing council meets next month, it is expected to raise its inflation forecast for the next two years close enough to its target to justify ending its net asset purchases faster than planned and to prepare for its first interest rate rise in over a decade.
Schnabel is one of the most influential voices on the ECB board and her comments are likely to shift the debate in favour of the increasingly vocal minority of hawks on its governing council who want to withdraw its stimulus more quickly.
While wage growth remains subdued in Europe, compared with the US or UK, Schnabel said the ECB needed to anticipate whether it was likely to pick up, as indicated by recent survey data, and act before it did. “Because once it’s there, it’s relatively costly to fight,” she said.
“We also have to ensure that current high inflation does not become entrenched in expectations because that could then give rise to a wage-price spiral,” she warned.
The German economics professor, who joined the ECB board just over two years ago, also cited three factors that made its policymakers more worried about the impact of inflation: the Omicron wave of coronavirus infections was milder than feared; the labour market had rebounded swiftly from the pandemic; and a 26 per cent annual rise in industrial producer prices indicated “quite a bit of pipeline pressure”.
“We are getting to a point where in light of the inflation outlook, the benefits of further net asset purchases may not justify the additional costs,” she said. “There is an argument for ending net asset purchases.”
The ECB is monitoring tensions between Russia and Ukraine for their impact on energy prices and the wider economy, she said, adding that a potential conflict was unlikely to speed up the ECB’s withdrawal of stimulus because of “the likely negative effects of an escalation of the crisis on growth and confidence, including through potential sanctions”.
Rising market expectations of a “hawkish” shift in ECB policy have already led to a fall in eurozone government bond prices and increased the spread between the borrowing costs of Germany and those of more indebted countries such as Italy.
Schnabel said the ECB was “ready to counter severe market dislocations that lead to fragmentation”, while adding that bond yields remained low by historical standards.
“Even if current bond yields adjust upwards, average interest rates on the countries’ debt will stay low for an extended period of time,” she said, pointing out that the eurozone was still expected to grow strongly. “In a growing economy, rising yields are not a major concern.”