ECB urged to give more weight to housing in inflation fight

The chief economist of the European Central Bank has called for housing costs to be given more weight in the way inflation is measured in the eurozone.

Philip Lane’s desire to shake up how inflation is calculated seems certain to fuel suspicion that the ECB is moving the goalposts to make its main target easier to hit after years of falling short.

In an interview with the Financial Times, Mr Lane also listed several factors that could lift inflation towards the central bank’s objective, including new trade tariffs, higher energy costs and rising wages among workers — all of which put pressure on companies to raise prices.

“There cannot be a permanent disconnect between labour costs and prices,” he said. “The narrative of ‘everything is inevitably low for longer’ — there is a lot of weight to that — but I do not put all my probability on it. You should watch out for other forces.”

In September, the ECB cut interest rates deeper into negative territory and restarted its €2.6tn programme of buying bonds in a hotly debated move to see off the threat of deflation. Inflation inched up to 1.4 per cent in January but remains well below the ECB’s target of below but close to 2 per cent.

Many investors and economists are unconvinced that extra inflation will materialise. Achieving the target is the ECB’s primary mandate, meaning the bank has to keep eurozone interest rates low if prices are not increasing quickly enough.

“You really do not want to get into a situation where a negative shock can drive you into deflation,” said Mr Lane.

The economist is widely seen as the monetary policy brains behind Christine Lagarde’s presidency of the ECB and his comments come as the bank embarks on a rare review of its strategy. Launching the process in January, Ms Lagarde said the bank “cannot operate as we did back in 2003”, the year of the last such exercise.

The EU has long debated if it should follow the US, UK and other countries by including the cost of owner-occupied housing in its inflation data, even though it is hard to measure. Rental costs make up only 6.2 per cent of the basket used to calculate eurozone inflation — far below the share of income most people spend on housing.

As house prices and rents rise across Europe, economists sense a public perception that the ECB is out of touch on inflation, which risks undermining support for its policies. “The ECB needs to find a way to rebuild trust with eurozone citizens,” said Sylvain Broyer, chief economist for Europe at Standard & Poor’s.

It would be very difficult for a central bank to raise the weight of house prices without incurring the suspicion the only reason is to artificially reduce the gap with its target

Mr Lane said he had started to present adjusted inflation figures that give extra weight to housing costs in ECB rate-setting meetings. Currently this adjusted figure is about 20 to 30 basis points higher, but at other times could have a deflationary effect.

“We at the ECB would agree that there should be more weight on housing — but there is a difficulty and this has been looked at several times before,” he said. “We have to learn and review from the previous episodes of studying this issue.”

The European Commission, which publishes inflation data via its Eurostat arm, last decided in 2018 not to change the way it makes its calculations.

Any switch is likely to be technically complex and controversial.

“It would be very difficult for a central bank to raise the weight of house prices without incurring the suspicion the only reason is to artificially reduce the gap with its target,” said Gilles Moec, chief economist at Axa.

Undershooting the inflation target is the main challenge confronting Mr Lane, a softly spoken Dubliner who joined the ECB last summer. He is all too familiar with the damaging effects of deflation on an economy, having seen them up close as head of Ireland’s central bank, which he ran from 2015 until last year.

Few doubt the 50-year-old’s qualifications for one of the top jobs at the ECB, which has taken on extra importance in light of Ms Lagarde’s lack of expertise in monetary policy or economics.

After coming top of his economics class at Trinity College Dublin, Mr Lane went on to a doctorate at Harvard University before working as a lecturer at New York’s Columbia University and becoming an award-winning professor back at Trinity.

When asked why inflation has been so stubbornly low, he downplayed the impact of shifts in the economy, such as demographics or digitisation. Instead, he said Europe was still recovering from the dual shock of the 2008 financial crisis and the subsequent eurozone sovereign debt crisis.

He pointed to several factors that could push inflation upwards, while admitting that the underlying causes may weigh on growth. “I would not like to call forces that raise inflation ‘upside risks’ because they may be bad news for the global economy, like deglobalisation,” he said. “But there could be forces that are inflationary that could kick in — trade and geopolitical forces.”

Drawing a distinction between inflation in services, which is close to the ECB’s target, and inflation in manufacturing, which is closer to zero, Mr Lane said companies in sectors with more global competition, like carmaking and electronics, were reluctant to raise prices for fear of losing market share.

“You can also imagine scenarios where if it turns out that the market conditions favour the ability to raise prices that could also happen globally,” he said.

As unemployment has fallen in Europe, wages have risen for the past couple of years, putting pressure on companies to lift prices. Meanwhile, protectionism is likely to disrupt manufacturers’ supply chains and push up costs.

Green energy policies to tackle climate change could also fuel inflation, he said. “If the world does adopt more transition friendly policies that mean that the consumer price of energy trends upwards then that could be a force that contributes to inflation dynamics,” Mr Lane said.