Price increases and interest rates: Inflation is falling, but the ECB should stay the course

There is a remarkable change in the world of prices.

Inflation appears to have peaked.

While the inflation rate in the euro area was 10.6 percent in October last year, it fell to 10.1 percent in November and 9.2 percent in December.

It could rise again somewhat in January, but according to many economists, new highs are unlikely to be reached.

That doesn't mean that prices in supermarkets won't keep climbing.

From bread to butter and fruit to wine, many things have recently become more expensive.

For the year as a whole, price increases remain extreme.

But the level of consumer prices, measured by the statisticians' basket of goods, is no longer rising as sharply as before.

What's happening in March?

What this means for the monetary policy of the European Central Bank will now be exciting.

The next rate meeting is in a week and a half.

The ECB now has to muster the strength to stay on course, even if inflation rates are no longer in double digits and key interest rates have gone through four impressive rounds of increases.

ECB President Christine Lagarde confirmed in Davos that the ECB would continue to raise interest rates, other ECB council members made similar statements.

So a 0.5 percentage point rate hike in February seems a foregone conclusion.

The interest rate decision in March is likely to be more controversial.

To be honest, no one knows exactly where that interest rate will end up at which the ECB starts to tighten and slow down the economy.

The higher interest rates rise, however, the louder the voices that believe that the target has been reached or exceeded.

There is already speculation as to whether it might only be enough for a rate hike of 0.25 percentage points in March.

And the financial markets show that some of them are even expecting interest rate cuts, at least for the second half of the year.

Rate cut speculation

There are three arguments in favor of such interest rate cuts, which the ECB itself never promised.

First, inflation may turn out to be falling faster than expected after all.

That cannot be ruled out;

it is quite possible that the fall in inflation is now being underestimated in the same way that the rise was previously.

Second, the recession could be deeper than expected;

one does not want to hope so.

And thirdly, the American Federal Reserve could lead the way with interest rate cuts - and the ECB behave as a "Fed follower".

But there is an important argument why the ECB should be more afraid of doing too little than too much right now.

If the inflation development slips away from you, it is associated with disproportionately higher costs to catch it again than if it turns out that it overdid it with the interest rate hikes over the course of the year and then has to make adjustments.

In addition, although inflation has fallen a little, it is still far from the central bank's target of 2 percent.

Even the ECB itself expects inflation to average 6.3 percent this year.

The central bank must focus on its goal

In this situation, it is crucial that the ECB keeps its goal in mind, price stability.

Indeed, inflation can have the nasty quality of solidifying if it persists for some time.

The past year will be remembered as a year when there was suddenly a two before the decimal point when it came to the price of petrol at the petrol station, when in the supermarket you could no longer help but be amazed at the price of groceries that had become more expensive - and when heating costs rose partially doubled.

For one thing, many workers may turn a blind eye if wages haven't risen as inflation would have suggested.

But the longer inflation persists, the less willing they will be;

totally understandable.

So it's no wonder that ECB chief economist Philip Lane has recently paid particular attention to how wages are developing - and whether that could also boost inflation.

Otherwise there are many imponderables.

Nobody knows how the war in Ukraine will continue, how the winter will develop and how energy prices will react.

The fact that the inflation rate fell in December had a lot to do with state interventions such as the assumption of the December gas deduction by the state in Germany, but also with the lower oil price.

The ECB interest rate hikes were felt somewhat when the euro exchange rate was stronger.

However, it will be some time before they fully show their effect.