Makhlouf backs May rate hike, but what comes next?

As we get ever closer to the European Central Bank’s next decision on interest rates, scheduled for May 4th, the words of central bankers become more and more pertinent. Central Bank of Ireland governor Gabriel Makhlouf spoke at the regulator’s Financial Industry Forum on Friday. At this stage nobody involved in setting the interest rates can make a serious speech without referring in someway to what may happen at the meeting in a fortnight. In practice though, members of the ECB’s governing council try to make as little news as possible. With markets and mortgage holders on edge this is no time to set the horses running.

So it proved with Makhlouf on Friday. He joined a chorus of voices in recent days signalling a hike in the first week of May would be appropriate.

“On the evidence so far, it is too early to start planning for a pause in our tightening of policy,” he said, according to a copy of his remarks published by the Central Bank. “Indeed, and again based on the evidence we have to date, rates will need to continue at restrictive levels to help reset the balance between supply and demand in the economy and bring down inflation,” he added.

[ Core euro zone inflation edges up in March, keeping ECB on alert ]

That’s fairly clear-cut. What was left unsaid, of course, was what happens after May.

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There is little doubt that the European economy is slowing down, but there is intense debate among economists about whether inflation is coming down at a sufficient pace to warrant the ECB pausing its programme of interest-rate hikes over the summer. So-called core inflation, which strips out volatile elements such as energy costs, is seen as providing a better picture of underlying price movements. That measure remained stubbornly high across the euro zone last month., suggesting more rate hikes will have to come.

The ECB’s big fear is that inflation slows a bit, but remains well above its 2 per cent target and becomes entrenched in the economy. The danger is that hiking too aggressively can wreck an economy. No matter how high inflation is, few politicians are willing to accept a sharp increase in unemployment to tame price growth.

Big decisions for the ECB are ahead.