Speaking at a Dutch parliamentary hearing, ECB Governing Council member and Dutch central bank head Klaas Knot highlighted the optimistic stance of financial markets about inflation, and warned about the potential pitfalls.

“Financial markets are extraordinarily optimistic and are expecting inflation to drop as fast as it rose. For next year even rate decreases are already priced in,” Knot observed.

However, the Dutch central bank chief noted that this rosy outlook might invite unforeseen challenges, especially if the path to inflation stabilization necessitates a longer than anticipated period of monetary tightening. This could potentially reignite tension within the financial markets.

“Exactly in such a situation, a longer than expected period of monetary tightening to keep inflation in check will increase the risk of renewed stress on financial markets,” he cautioned.

In an interview by De Tijd, ECB Executive Board member Isabel Schnabel noted that “given the high uncertainty about the persistence of inflation, the costs of doing too little continue to be greater than the costs of doing too much.”

She emphasized “once inflation has become entrenched in the economy, it becomes much more costly to fight it,” adding that “We have more ground to cover. It will depend on the incoming data by how much more rates will have to increase.”

On the topic of market expectations of two more additional 25bps hikes, Schnabel remained data-driven. She responded, “That will depend on the incoming data. Let me be very clear: A peak in underlying inflation would not be sufficient to declare victory: we need to see convincing evidence that inflation returns to our 2% target in a sustained and timely manner. We are not at that point yet.”

Regarding monetary policy transmission precess, Schnabel explained, “A rise in the policy rate first has an impact on financing conditions, then on the real economy, and ultimately on wages and prices.” She revealed that ECB’s staff analysis suggests the effects of tighter monetary policy are currently in progress, with the impact on inflation expected to peak in 2024.

However, Schnabel cautioned that uncertainty persists around the strength and speed of this process, admitting, “it may take longer than was previously the case to see the impact of our policy.”

Full interview of ECB Schnabel here.

According to the latest Consumer Expectations Survey conducted by ECB in April, consumer inflation expectations have taken a significant downturn, reversing most of the gains made in the previous month.

The survey revealed that mean inflation expectations for the coming 12 months dropped from 6.3% to 5.3%. Median inflation expectations for the same period also saw a decline, dropping from 5.0% to 4.1%. These results mark a decrease even below February readings, which were at 5.8% and 4.6% respectively.

Looking further ahead, mean inflation expectations for three years in the future also slid down from 4.3% to 3.8%. Similarly, median expectations for this timeline dropped from 2.9% to 2.5%.

However, consumer sentiment regarding economic growth over the next 12 months displayed less negativity. The mean expectations for economic growth in the next year edged up from -1.0% to -0.8%. Meanwhile, median growth expectations remained static at 0.0% for the next 12 months.

Full ECB Consumer Expectations Survey here.

Christine Lagarde, President of ECB, acknowledged the persistence of robust price pressures in her recent speech. She pointed out that both headline and core inflation continue to face “upside pressures… from the pass-through of past energy cost increases and supply bottlenecks.”

Speaking on the current state of underlying inflation, Lagarde said, “The latest available data suggest that indicators of underlying inflationary pressures remain high and, although some are showing signs of moderation, there is no clear evidence that underlying inflation has peaked.”

Lagarde also highlighted the intensifying wage pressures, noting that “wage pressures have strengthened further as employees recoup some of the purchasing power they have lost as a result of high inflation.”

Lagarde also drew attention to the forceful impact of the central bank’s rate hikes on financial conditions. “Our rate hikes are being transmitted forcefully to financing conditions for firms and households, as can be seen in rising lending rates and falling lending volumes,” she stated.

Notably, she mentioned that “the full effects of our monetary policy measures are starting to materialise,” adding that future ECB decisions are geared towards ensuring a “timely return of inflation to our 2% medium-term target.” She asserted, “Our future decisions will ensure that the policy rates will be brought to levels sufficiently restrictive… and will be kept at those levels for as long as necessary.”

Full speech of ECB Lagarde here.