(Bloomberg) -- The European Central Bank should be ready to adjust monetary policy in either direction as spiking energy costs and the conflict in Ukraine send inflation soaring but also weigh on growth, according to Chief Economist Philip Lane.
One of the ECB's most dovish officials, he stressed policy makers' extra room to maneuver after they weakened the link between withdrawing stimulus and the first increase in record-low interest rates. Lane said it's important to maintain optionality, and for that optionality to be “two-sided.”
“We should ensure that our policy settings are adjusted if deanchored inflation expectations, an intensification in catchup wage dynamics or a persistent deterioration in supply capacity threaten to keep inflation above target in the medium term,” the Executive Board member told the Paris School of Economics in a speech Thursday.
On the other hand, “we should also be fully prepared to appropriately revise our monetary-policy settings if the energy price shock and the Russia-Ukraine war were to result in a significant deterioration in macroeconomic prospects and thereby weaken the medium-term inflation outlook,” Lane said.
The ECB is facing increasing pressure to end more then two years of negative rates, with inflation readings this week from Germany, France and Spain exceeding expectations after Russia's invasion. Price gains in the euro area may only peak in the next two to three months, according to ECB Vice President Luis de Guindos.
Austria's Robert Holzmann -- one of the Governing Council's leading hawks -- backs quarter-point hikes in the deposit rate, which is currently at -0.5%, in September and December. Money markets see an even quicker path to zero, betting it will happen by October.
But the war is also weighing on economic expansion, with confidence sinking and governments starting to downgrade outlooks. The longer it lasts, “the greater the costs are likely to be,” ECB President Christine Lagarde said Wednesday, describing “significant risks to growth” and advocating only gradual monetary-policy normalization.
Despite the conflict, the ECB this month announced an accelerated exit from asset purchases that have been partly blamed for inflation being almost three times the 2% official goal. That's raised concerns of excessive divergence in borrowing costs between the euro zone's 19 members.
The ECB has already earmarked reinvestments from its pandemic-era PEPP bond-buying program to tackle so-called fragmentation. Lane said it's prepared to use a range of tools to prevent such a scenario from interfering with efforts to combat inflation.
“Under stressed conditions, flexibility will remain an element of monetary policy whenever threats to monetary-policy transmission jeopardize the attainment of price stability,” he said. “This means that we are ready to use a wide range of instruments to address fragmentation.”
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