Policy shouldn't make inflation fight 'more difficult', says Central Bank governor
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With inflation continuing to slow and the European Central Bank (ECB) announcing another interest rate cut, Ireland finds itself in a much better position than many of its eurozone peers, but the Governor of the Central Bank of Ireland has warned that we have to ensure “we're not making things more difficult for ourselves” when it comes to dealing with inflation given the current capacity constraints in the economy.
Gabriel Makhlouf's comments come following the Budget earlier this month which increased spending far above what the Government’s own fiscal rules would have allowed despite repeated warnings from the Central Bank, among many other economic institutions, that higher spending could lead to higher rates of inflation.
In addition to the Government putting more money into people’s pockets — through once-off measures and its tax package — on Thursday, the ECB announced another interest rate cut of 0.25%, its third this year and its first back-to-back rate cuts in 13 years.
The cut will immediately benefit the approximately 180,000 tracker mortgage customers as well as making borrowing cheaper. The ECB has one more meeting scheduled for December where another interest rate cut is potentially on the cards as inflation continues to slow.
Annual inflation across the eurozone — as measured by the harmonised index of consumer prices — dropped to 1.7% during September from 2.2% in August. While some other countries are dealing with higher rates — such as Romania, Belgium, and Poland all of which are above 4% — Ireland’s inflation rate was flat at 0%, the lowest in the bloc.
While the process of disinflation continues — with the ECB expecting to hit their medium-term target of 2% next year — the economic outlook of the eurozone has become more of an issue.
An ECB survey of firms recorded a further slowdown in business momentum in September but growth is likely to remain positive with gains in the services sector offseting a contraction in the manufacturing sector.
However, Germany, the biggest economy in the eurozone, could already been in recession which is dragging down growth across the rest of the bloc.
In an interview with the , after the ECB announced its latest interest rate cut, Mr Makhlouf said while other countries may be seeing their economic picture weaken in recent months, it is “definitely not” the case in Ireland.
In Ireland, the Central Bank believes that the Irish economy is resilient and is is poised to grow by between 2% and 3% until 2026. Unemployment is also expected to remain low, supporting a rise in wage rates and broader household incomes.
Despite Ireland being in a better position than other larger eurozone members — particularly on inflation and economic outlook — Mr Makhlouf said he does not believe that the ECB’s interest rate decisions will have a detrimental impact on the country.
He said the reality is that developments in bigger eurozone economies such as Germany, France, Italy, and Spain “will impact” the eurozone but the ECB’s role is to make sure that inflation in the eurozone remains stable and on target.
“It's sort of understandable that if there's a big impact in Germany, it's something that we're going to notice. It is in Ireland's interest that price stability in the whole of Europe actually is delivered. It's not in our interest that the European economy, minus Ireland, suffers from inflation.”
"In Europe, we have a single monetary policy, but we've got 20 fiscal policies. It's a fragmented framework. It just means that in Ireland it's really important that we make sure that, in the light of the decisions being made in Frankfurt, we're not making things more difficult for ourselves,” he said.
Earlier this month, Finance Minister Jack Chambers and Public Expenditure Minister Paschal Donohoe unveiled a budget package of €10.5bn which was made up of once-off measures worth €2bn, total expenditure increases of €6.9bn — which included additional capital expenditure of €1.6 billion — as well as permanent tax changes worth €1.4bn.
This is well ahead of the €8.3bn budget package announced during the summer economic statement which would have increased expenditure by 6.9%. Prior to the Budget, Mr Makhlouf had advised the Government not to go beyond its own rule limiting spending increases to 5% a year.
He said he is “concerned” that the Government felt it was necessary to go above and beyond its own spending rule and the way in which it was done adding that the Central Bank has calculated that these breaches of the spending rules will add to inflation.
Mr Makhlouf said budgets are political choices and it was not his place to go into the decisions the ministers made but “it has not, in my view, set the overall stance in a way that doesn't add to inflation”.
“It's added in a way that increases the risk of domestic inflation, which is what we're seeing across Europe, incidentally, in the sense that domestic inflation is the bigger risk at the moment,” he said.
On the additional capital allocation in the Budget, he said “it probably hasn't prioritised it in the way that I would have liked”.
He said: “I think what matters now is how precisely it decides to spend that and the decisions it makes around that.
Mr Makhlouf said the economy in Ireland is doing “reasonably well” but his concerns stem from the fact that the economy in Ireland is operating at capacity and additional stimulus could lead once again to price increases.
He said the country needs fiscal policy that supports monetary policy as “we need to be careful” that fiscal policy “doesn’t put further pressure and strains on that capacity which then leads to increases in inflation” which could in turn impact households and harm the country’s competitiveness.
"I think we're in a good place, but that shouldn't mask the fact that there are some medium-term challenges, particularly around infrastructure, that need to be addressed,” he said, adding that the issues around infrastructure, particular the lack of housing, is negatively influencing whether businesses decide to invest in Ireland or not.
On the inflation side, Mr Makhlouf said the ECB’s restrictive monetary policy is working and disinflation is taking place but they may need a “little bit longer” before they are confident that their policy settings will get to their 2% in a sustainable way but “we're not far away from that”.
"There are sort of big risks that we can't control out there. The whole geopolitical side is riskier than ever in some respects, and that could have effects that we can't control. We just need to keep an eye out,” he said.
Mr Makhlouf added that he doesn’t believe that interest rates should have been cut faster despite the economic uncertainties across Europe.
"I certainly don't think we should have gone faster. My own sense is that there certainly have been some surprises, but I think the nature of what we're seeing, in my view, is more structural problems.
"Obviously monetary policy has a role to play in it, but it's not the major player. It's far more important to support economic growth by getting inflation down and arriving at price stability,” he said.
"So my focus really has been on achieving our price stability target, 2% in the medium term. Clearly, what's happening is the economy will play straight into that, but I personally don't make monetary policy decisions based on what's happening in the economy. Make them based on where I see inflation.”
While the interest rate cut was in the context of inflation falling faster than expected, it was also seen as a means to prop up the eurozone economy which has been faltering in recent months.
ECB president Christine Lagarde said she does not believe that the eurozone is heading towards recession despite some of the negative economic markers and they are “still looking at that soft landing”.
Ms Lagarde said they expected the economy to strengthen over time as rising real incomes allow households to consume more and easing interest rates allow more investment.