ECB Eyes Second-Round Effects: Villeroy's Warning

Villeroy's remarks come amid rising concerns that persistent inflation could trigger wage demands, creating a self-reinforcing cycle. The ECB has raised rates aggressively since July 2022, but core inflation remains sticky above 5%. Second-round effects occur when firms pass on higher costs to consumers, fueling further price increases.

The ECB's vigilance reflects its commitment to bringing inflation back to the 2% target without causing a recession. Villeroy noted that while inflation is easing, the battle is not yet won. The central bank's data-dependent approach means future rate decisions will hinge on incoming economic indicators.

Analysts interpret Villeroy's comments as a signal that the ECB may pause rate hikes if second-round effects fail to materialize. However, the risk of overtightening remains, given the eurozone's fragile economy. Markets now price in a terminal rate of 4%, with a potential cut in mid-2024.

Power Move: Villeroy's statement buys the ECB time to assess data without committing to further hikes. If second-round effects stay absent, expect a prolonged pause—but any wage spike will trigger immediate tightening. The eurozone's inflation fight hinges on labor market dynamics in Q4 2023.

This article was edited with AI assistance for readability. Read original here.