FRANKFURT, Oct 5 (Reuters) - Surging energy costs, higher yields and shrinking budget support could all weigh on economic growth and may limit how much the European Central Bank needs to tighten policy to quell price pressures, Philip Lane, the bank's chief economist, said.
The ECB has raised interest rates twice this summer as inflation surged to nearly twice its 2% target, and policymakers are now debating just how much more they would have to do given high energy costs and surprisingly resilient
growth.
Lane said that while the recent wave of energy price increases was creating a clear upside risk for inflation, other factors were proving a drag, so the bank's policy of a 'measured' response to high inflation remained appropriate.
Among the drags, he said high energy costs, lower budget support and the recent surge in market-based borrowing costs would all weigh on the economy by curbing demand.
"While growth has been holding up this year, the fiscal impulse is projected to turn from positive in 2026 to negative in 2027 and 2028, and the notable recent increases in long-term interest rates will slow growth and reduce pass-through by more than projected," he told a conference in Frankfurt.
The jump in AI-related investment was a positive for the economy but tech companies were borrowing so heavily to fund their oversized investments that this added to the upward pressure on interest rates, Lane said.
"All else being equal, these 'demand destruction' channels can limit the required adjustment in the monetary stance to ensure the timely return of inflation to the target," he said.
Lane, however, did not comment on the next policy move and said decisions will be taken meeting by meeting.
VOLATILE RATE HIKE EXPECTATIONS
Financial markets see another two to three rate hikes from the ECB in the coming year but these expectations are highly volatile as four moves were fully priced in less than a week ago before an abrupt repricing.
Lane also argued that there has been no upward shift in medium-term inflation despite the near term surge, an argument Bundesbank President Joachim Nagel appeared to back.
"There are so far no clear signs that inflation has fed through to price and wage setting," Nagel said in a speech in Sorrento, Italy. "Longer-term market-based and expert expectations remain consistent with the Eurosystem’s 2% inflation target."
Still, Nagel too warned that risks to inflation were to the upside as natural gas prices could still go higher, refinery capacity destruction put pressure on margins and food prices were also under upward pressure.
(Reporting by Balazs Koranyi; Editing by Alexandra Hudson and Toby Chopra)
