For the first time in more than a year, the Governing Council of the European Central Bank (ECB) announced Thursday it would not be hiking three key ECB interest rates again, noting that rates are already high enough to bring euro area inflation back down to its target 2 percent in time. The main question now is how long these interest rates should be kept as high as they are, Bank of Estonia Governor Madis Müller said Friday.
"I am pleased to confirm that inflation in the euro area is clearly coming down," Müller said in a statement issued Friday. "We at the Governing Council of the ECB have been taking steps for nearly two years now to bring excessively high inflation under control. Consumer prices in the euro area were on average 4.3 percent higher in September than they were a year earlier, but the ECB's target is annual inflation of 2 percent."
Another issue that is critical to inflation is that geopolitical tensions are causing energy prices to rise again.
Geopolitical tensions are causing energy prices to rise again, and the conflict in the Middle East and the danger of it spreading are thus one of the main risks facing the decline of euro area inflation, he noted. Regardless, inflation is still too high, and one of the main causes behind this in the euro area is the relatively fast, nearly 5 percent growth in wages.
"It is entirely understandable that people expect that their wages should rise to recover as much purchasing power as possible that was lost to high inflation," Müller said. "This is encouraged by the continuing good performance of the labor market, where unemployment has remained at record low levels for the euro area. Fast wage growth increases costs for businesses, and that may then push them to look for ways to raise their prices."
He noted that the first signs of wage increases slowing in the euro area are discernible, but wages rising quickly for a longer period means that it will take longer for overall inflation to come down.
According to Estonia's central bank chief, the latest news about the state of the economy in Europe as well as its short-term outlook are generally pessimistic in tone. Industrial output likely continued to decline in October, credit growth has slowed and investment has been quite weak in housing as well as by businesses in expanding their activity.
"Industrial companies have been facing relative difficulties over the past year, but in recent months, companies have become more pessimistic in the service sector as well, especially business services," he said.
"Companies providing tourism and travel services have been doing better thus far, though," Müller continued. "This is also evident in Estonia, and I almost missed my flight heading to the Governing Council meeting this week because it was nearly impossible to find parking at Tallinn Airport."
Overall, however, the decline in borrowing and investment and the relative weakness in general economic activity over the past year are to be expected, given the sharp rise in interest rates.
Slowing inflation best recent news for Estonians
One positive detail in the recovery outlook for the euro area economy is that European companies' ability to export has been supported by the relatively good performance of the U.S. economy, the central bank governor highlighted. China's GDP growth figures have also been better than expected in the past quarter, although problems appear to persist in its real estate sector.
"When describing the state of the economy in the euro area, it is more accurate overall to talk about stagnation and a weak recovery rather than about any deep economic crisis," Müller said, noting that getting inflation under control does not necessarily require the ECB to use high interest rates to drive the economy into a deep recession.
"It still remains probable that the euro area economy will grow gradually in the coming year, and this should be helped by purchasing power recovering as inflation remains below the average increase in wages," he continued. "We see the same for Estonia, where a recovery in the economy depends above all on the economies and demand improving in other European countries that are important target markets for Estonian exporters."
Lower inflation and a consequent recovery in purchasing power, meanwhile, is some of the best economic news people in Estonia have gotten recently, Müller acknowledged.
"Inflation in Estonia exceeded 20 percent in the second half of last year, but it was down to 4.2 percent this September, which is a hair's breadth below the euro area average," he highlighted.
Higher interest rates 'lesser of two evils'
"Choosing between high inflation that affects the whole of society and higher interest rates means choosing the lesser of two evils," Müller admitted. "It's clear, though, that the problems caused in the economy by high inflation are much greater."
He explained that the way for central banks to tackle excessively high inflation is to raise interest rates, although doing so makes life more difficult for borrowers.
"It is of course the [ECB's] job to focus on keeping inflation under control, as it's clear that the problems caused by high inflation pose a much greater threat to the economy," he continued. "People in Estonia agree with this."
According to Müller, a recent survey by Faktum & Ariko found that 71 percent of respondents regarded high general inflation the worst economic issue, "While 11 percent of respondents considered rising loan interest rates and loan repayments – an unavoidable consequence of the fight against high inflation – to be a greater menace."
Click here to read more from the ECB regarding Thursday's monetary policy decisions.
Editor: Aili Vahtla