On the basis of the analytical framework described above, any loosening of monetary policy should in theory start before the cyclical downturn; it must start before economic activity falls below its potential level. But to start the loosening cycle inflation expectations need to be firmly anchored, in line with the central bank’s definition of price stability.
If interest rates are reduced in a context of rising inflation expectations, there is a risk of dis-anchoring them which would jeopardise the effectiveness of the policy move. This refers to expectations prevailing not only in the financial markets but also in the goods and labour markets.