Euro zone inflation has entered a new phase which could linger for some time, requiring the European Central Bank to keep policy tight and avoid declaring an end to rate hikes, ECB President Christine Lagarde said on Tuesday.
The ECB has raised rates at each meeting over the past year, taking its deposit rate to 3.5%, and promised even more tightening as soon as July as it hopes to arrest inflation.
"It is unlikely that in the near future the central bank will be able to state with full confidence that the peak rates have been reached," Lagarde told the ECB Forum on Central Banking in Sintra, Portugal.
The issue is that relatively quick wage growth is now keeping inflation under pressure as workers try to recoup earnings lost to inflation and this process is amplified by lower than expected productivity growth.
Lagarde argued the resilience of the labour market and the composition of employment growth are both contributing to this dynamic and both of these factors could linger, potentially prolonging inflationary pressures.
While the bloc suffered a recession in recent quarters, firms are holding onto workers, an unexpected development which is fuelling wage growth.
"That disconnect partly reflects increased labour hoarding by firms in a context of labour shortages," Lagarde said. "This is weighing on productivity growth and... the motivation for firms to hoard labour may not disappear quickly."
Another issue is that much of the employment growth is coming in sectors with historically low productivity growth
"All this means that we will face several years of rising nominal wages, with unit labour cost pressures exacerbated by subdued productivity growth," she said.
These developments will force the ECB clearly commit to holding rates high for an extended period.
"This will ensure that hiking rates does not elicit expectations of a too-rapid policy reversal and will allow the full impact of our past actions to materialise," Lagarde said.
