ECB governors see rising risk of rate hitting 2% to curb inflation

Inflation has risen to 9.1% in August, which is above the ECB’s 2% target for the next two years. The central bank has been increasing its interest rates at an unprecedented pace and urging governments and other government agencies to lower energy bills that have soared since Russia invaded Ukraine.

On Thursday (8 September), the ECB increased its deposit rate to 0.75%. President Christine Lagarde suggested that another two to three increases could be made. However, rates are still far from a level that will see inflation return to 2%.

Five people familiar with the matter stated that many policymakers believed that the rate would need to be raised to "restrictive territory". This is jargon that refers to a rate that causes the economy's slowdown at 2% or higher.

Sources spoke under condition of anonymity to discuss policy deliberations. They said that this would likely occur if the ECB's 2025 inflation projection, which is due to be published in December and still above 2%, is released.

A spokesperson for the ECB declined to comment.

The ECB sees inflation at 2.3% by 2024. However, one source claims that an internal forecast presented at Thursday's meeting suggested it could be closer to 2%, after taking into consideration the recent gas prices.

Klaas Knot, the Dutch central bank governor, and Pierre Wunsch, Belgium's prime minister, were the first to talk openly about entering restrictive territory late last year. This was at a time in which most of their colleagues believed that interest rates should return to between 1% to 2%.

According to sources, policymakers are anticipating a recession this winter as well as weaker economic growth next fiscal year than the official 0.9% projection by the ECB. They added that some people took comfort in the strength of the labour market which should mitigate the negative effects of higher rates.

The sources claimed that policymakers began a discussion at Thursday's meeting about the tens billions of euro that the ECB could pay to banks for excess reserves. This was after the deposit rate has turned positive again.

Sources said that policymakers considered that the current proposals, which included one for a "reverse-tiering system" that would cap remuneration on certain reserves, required more work. One source said that a decision could still be made at the ECB’s next policy meeting, 27 October.