Key facts
- Euro zone inflation is 3.8%, nearly double the ECB's 2% target.
- Bundesbank President Joachim Nagel sees no clear signs of second-round inflation effects.
- Longer-term inflation expectations remain consistent with the ECB's 2% target.
- Nagel warned price pressures are expected to stay strong, excluding food and energy.
- High energy costs could drag on growth and limit the need for ECB policy tightening, according to Philip Lane.
Euro zone inflation is running at 3.8%, nearly double the European Central Bank's 2% target, with upward risks dominating, according to Bundesbank President Joachim Nagel. However, Nagel stated that expensive energy has not yet clearly fed through to wages and other prices, which could perpetuate rapid price growth.
"There are so far no clear signs that inflation has fed through to price and wage setting," Nagel said in a speech in Sorrento, Italy. He added that longer-term market-based and expert expectations remain consistent with the Eurosystem’s 2% inflation target.
Despite this, Nagel warned that price pressures are expected to remain strong, even when excluding volatile food and energy prices. He cited risks such as low gas storage levels, potential for substantially higher gas volumes to be bought during winter, destruction of refining capacity driving up refined petroleum product prices, and risks to food prices from drought, wildfires, and fertilizer shortages.
European Central Bank chief economist Philip Lane said that the late summer surge in energy costs could be a drag on growth and that such 'demand destruction' episodes can limit how much a central bank must tighten policy to quell price pressures. Lane noted that while government spending was insulating the economy, the fiscal impulse is expected to decline in the coming years, adding to the drag on growth.
Financial markets expect the ECB to raise its 2.5% deposit rate two or three more times in the coming year, in addition to two hikes this past summer. Nagel, however, did not endorse these market bets, stating only that the ECB needs to be flexible and base decisions on incoming data. According to LSEG data, markets are pricing in a 20% chance of an interest-rate hike by the ECB in October and an 80% chance of an increase in December.
Regarding rising yields, Nagel noted this increases the relative attractiveness of bonds among reserve asset managers. He also stated that the case for diversification into gold remains significant due to continued geopolitical stress and credit risk associated with high debt levels.