French central bank chief forecasts three-year fight against inflation

France’s central bank chief has warned that it may take up to three years to bring inflation under control and that the European Central Bank (ECB) will continue to raise interest rates as long as underlying inflation is still rising.

François Villeroy de Galhau, who sits on the ECB’s rate-setting governing council, also said the UK’s recent skirmish with markets laid down a marker for other countries in terms of being “predictable” while highlighting a lack of regulation in the non-banking sector.

In an interview with The Irish Times, Mr Villeroy de Galhau said he expected inflation “to peak in the first semester of next year”.

“If you look at the energy component, which is significant, it will fade away starting probably from next spring,” he said. “If you look at evolution of prices in recent months, oil and more recently gas, they are at least stabilising and sometimes decreasing.”

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However, he warned that it would take up two to three years to bring inflation back towards 2 per cent, the ECB’s target rate.

Price pressure

Euro zone inflation surged to a record 10.7 per cent in October, again surpassing expectations, as price pressures intensified across the bloc.

So far, the euro area has avoided a recession but signs of slowdown are evident and several analysts forecast the economy to contract during the current quarter.

Mr Villeroy de Galhau said Frankfurt would continue to hike up rates while underlying inflation, which excludes energy and food, was rising. “As long as underlying inflation has not clearly peaked, we shouldn’t stop on rates,” he said.

Markets have priced in at least two more rate increases between now and March, bringing the ECB’s main refinancing rate, which affects mortgages, to 3 per cent.

“It’s too early to tell where the end point in interest rates, or the so-called terminal rate, could be. That said, we are not far from the neutral rate beyond which our hiking pace could be more flexible and possibly slower,” he said. The neutral interest rate is one that neither stimulates nor restricts economic growth.

Role of energy

While Mr Villeroy de Galhau did not discount the possibility of a recession in the euro zone, he said the bank’s baseline forecast for next year was still positive while noting that employment was still strong. “This means that we can raise interest rates without provoking significant unemployment,” he said.

“To determine the level of growth next year, energy is more important than monetary policy. Our aim is not to provoke a recession but to tame inflation,” he said.

On whether the ECB had been slow to act on inflation, Mr Villeroy de Galhau said: “Nobody had forecast the surge in European inflation… as soon as we saw the first signs of the inflationary surge – one year ago before the Ukraine war – we started to normalise monetary policy while stopping PEPP [pandemic emergency purchase programme] purchases.”

On the UK’s recent financial turmoil, he said there were many UK-specific elements, “starting with the mini budget”.

However, he said there were two lessons for other jurisdictions. “First you should be predictable. You shouldn’t add uncertainty to uncertainty,” he said. Mr Villeroy de Galhau also said the episode highlighted the lack of regulation in the non-banking sector as much of the market instability was linked to the liquidity of pension funds.