Monetary Policy | Bank of Finland’s Välimäki hints: the ECB may still raise interest rates

The slowdown in eurozone inflation towards the reliable two percent is still risky and will take a long time.

Bank of Finland member of the board of directors Tuomas Välimäki hints that the European Central Bank (ECB) may still continue to tighten monetary policy.

According to the forecast published by the ECB three weeks ago, in 2025 inflation will continuously exceed the two percent medium-term price stability target for more than four years.

In its interest rate decision, the Council estimates that the policy interest rates have now been raised to a level at which, if they are kept long enough, they will significantly promote the return of inflation to the target.

“However, when we take into account the risks to the development of inflation, this does not necessarily mean that interest rate increases are over. Since inflation remains faster than the target for such a long time, delaying the achievement of the target even further cannot be accepted,” says Välimäki in the press release.

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Välimäki is the CEO Olli Rehnin during the presidential election campaign as his deputy in the monetary policy decision-making council of the European Central Bank.

The Council’s statement three weeks ago was interpreted as a hint that interest rate hikes would not be continued. The market still considers the possibility that the ECB would continue to tighten monetary policy to be moderately small.

On the other hand, the ECB has repeatedly said that interest rate decisions are always made based on the latest available information.

In September inflation slowed down in the euro area more than economists’ expectations to 4.3 percent. Because of this, the perception that the ECB no longer needs to tighten monetary policy was strengthened in the market.

The ECB has raised its key interest rates by 4.50 percentage points after July 2022. The key interest rate, i.e. the deposit rate paid to banks, is now 4.00 percent as a result of the 0.25 percentage point rate hike made three weeks ago.

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The central bank’s interest rate hikes usually start to slow down the rate of inflation after six months and typically reach their full effect over a year.

Fast inflation is an international phenomenon, and the tight monetary policy to tame it limits demand worldwide.

According to Välimäki, interest rate hikes by central banks have been necessary to prevent the threatening price-wage cycle and to strengthen purchasing power.

The prolongation of rapid inflation has particularly harmed those households that have to use the vast majority of their income for the daily consumption of basic commodities.

Finland economic growth and inflation will slow down this year and next year more than the euro area average. According to the Bank of Finland, this is mainly due to factors other than the tightening of monetary policy.

Finland’s industry structure is more heavily weighted than average on industry and construction, which are sensitive to changes in interest rates. The same applies to Germany, which, based on several forecasts, will sink into recession this year.

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One additional reason for Finland’s weak economic development in the short term is, according to the Bank of Finland, the fact that housing loans in Finland mostly have variable interest rates. Therefore, the higher interest rate is quickly transmitted not only to new loans but also to the entire loan portfolio.

The increase in debt servicing costs reduces the income available for other consumption and thus domestic demand.

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