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Leaving inflation unchecked is bigger threat

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The cost of leaving inflation untamed is much higher for households and businesses, said Central Bank Cyprus governor Constantinos Herodotou.

Addressing the 14th Limassol Economic Forum in Limassol, Herodotou referred to the “difficult” monetary policy decisions taken by the European Central Bank in a bid to tame inflation, which in 2022 rose to record highs, hiking its base rates by a cumulative 450 basis points since then.

“The euro area is at a pivotal juncture…difficult times warrant difficult but necessary measures.”

The CBC Governor argued that leaving inflation untethered is much worse for the entire economy, whereas tightening monetary policy should eventually revert down to neutral when the 2% inflation target in the medium term is deemed sustainable.

“The decisions we make today about our economy will shape the economic trajectory for years to come.

“By working together, with a common vision, remaining focused on the appropriate policies, the euro area, including, of course, Cyprus, can forge a future that is prosperous and sustainable.”

Herodotou believes that monetary policy transmission is working, as inflation marked a notable drop to 4.3% in September from 4.3% the month before.

According to ECB projections, inflation is estimated to decline to 5.6% this year from 8.4% in 2022 and to drop further to 3.2% and 2.1% in 2024 and 2025, respectively.

“However, material uncertainty continues to persist in the euro area.”

He said the recent increase in energy prices could transmit again to the rest of the economy and have upward pressure on prices, while the elevated wages and profit margins observed in the euro area need to be monitored closely, even though they are currently expected to normalise.

“Liquidity conditions in the euro area banking system is another area to monitor since it plays a role in transmitting monetary policy and, consequently, affects inflation.

“These uncertainties are the reason why I believe the ECB Governing Council’s approach to be data-dependent in its interest rate decisions is indeed the right one.

“In other words, determine the appropriate level and duration of its tightening policy stance, based on incoming economic and financial data and the consequent projections”.

Herodotou emphasised the complementary role of fiscal policy in supporting and not counteracting the effectiveness of monetary policy in this currently challenging environment.

“It is important that governments employ only targeted fiscal measures, supporting the most vulnerable in society.

“Any horizontal measures should be avoided or rolled back to prevent an escalation in medium-term inflationary trends.

“Such horizontal measures risk extending the duration of high inflation, and consequently would force the extension of the duration of high-interest rates in order to tame inflation and bring it back to the 2% target”.