ECB hawks argue for more hikes even as Lane opens door to pause

FRANKFURT (Reuters) -The European Central Bank should err on the side of further interest rate hikes as inflation could come in even higher than it expects, two ECB policymakers said on Monday, even as the bank’s chief economist opened the door to a pause.

The ECB has raised rates by a combined four percentage points over the past year to stem a historic surge in inflation and said it would likely increase them again in July after its new forecasts put price growth above its 2% target through 2025.

“We need to remain highly data-dependent and err on the side of doing too much rather than too little,” ECB board member Isabel Schnabel, an outspoken conservative, or “hawk”, said in a speech.

Her fear, shared by Slovak central bank governor Peter Kazimir, is that if the ECB fails to root out inflation now, it could get entrenched in the economy, forcing policy to remain tight for even longer, causing hardship for euro zone consumers beyond what would be necessary.

“A continuation of monetary policy tightening is the only reasonable way ahead,” Kazimir, who often sides with Schnabel, said in a blog post.

But the ECB’s chief economist Philip Lane had a slightly different take, arguing that being data dependent could also mean not raising rates for one or more meetings and resuming on merit.

“Data-dependency could be you decide today not to raise rates, but then one meeting later, two meetings later, three meetings later, the data will say, well actually, you should start hiking again,” he told an event in Madrid.

He added the ECB was likely to raise interest rates again next month but it was too early to predict the decision of the September meeting, which will be shaped by incoming data.

The comments set up the debate over policy at a time when inflation is falling quickly but rapid nominal wage growth and robust demand for services risk slowing or even reversing disinflation.

Policy “doves” argue that rapid rate hikes have yet to work their way through the economy and the higher funding costs, combined with anaemic growth, will naturally cool price growth.

But Schnabel said excessive rate hikes can be reversed quickly, so the risk was “comparatively small” since entrenched inflation would mean protracted economic pain.

“It is very costly to react only after upside risks to inflation have materialised, as this could destabilise inflation expectations and thus require a sharper contraction in output to restore price stability,” she said.

(Reporting by Balazs Koranyi; Editing by Jon Boyle, Gareth Jones and Sharon Singleton)