Lane, the European Central Bank's chief economist and an executive board member, said on the 5th that the sharp rise in energy costs toward the end of summer could weigh on economic growth, and expressed the view that if demand destruction occurs, the degree of monetary tightening could be limited. The ECB carried out two rate hikes this summer, and markets, concerned about second-round effects on prices from higher energy costs, expect another two to three rate hikes over the coming year. Lane noted that, judging by underlying inflation indicators, an upward overshoot in medium-term inflation has not become entrenched, and said economic growth is more resilient than expected, supported by government spending and artificial intelligence investment, while also stating that soaring energy costs could have an adverse impact. He said the second wave of this energy supply shock poses a direct upside risk to the inflation outlook while representing a downside risk to the growth outlook, and that the demand-destruction channel could limit the adjustment in the monetary policy stance needed to bring inflation back to target. He said that while government spending is underpinning the economy, the fiscal stimulus effect is expected to shrink over the coming years, adding further weight on growth, and that monetary policy remains on a middle path, making a cautious approach appropriate for containing inflation.
Lane signals energy-driven demand destruction could limit the degree of ECB tightening, implying fewer/less aggressive rate hikes and thus lower policy-rate/yield expectations.
Lane's dovish signal that tightening may be limited by demand destruction reduces expected ECB rate hikes, weakening the euro versus the dollar.
