ECB’s de Cos: Must Keep Close Eye on Nominal Long-Term Rates, Act Appropriately

3 March 2021

By David Barwick – FRANKFURT (Econostream) – The European Central Bank must keep a close eye on nominal long-term interest rates and act as warranted to ensure that financing conditions remain favourable, ECB Governing Council member Pablo Hernandez de Cos said Wednesday.

According to a text provided by the Bank of Spain, which he heads, De Cos said in a speech at the Universidad Autónoma de Madrid that the increase observed since December in nominal long-term interest rates in the euro area had initially been accompanied by higher inflation expectations, so that real interest rates remained largely unchanged.

Even so, with expectations of inflation significantly below the ECB’s price stability objective, he said, more helpful in terms of the recovery and the achievement of price stability would have been a reduction in real interest rates.

‘More recently, increases in nominal long-term rates have not been matched by increases of the same magnitude in long-term inflation expectations, leading de facto to some increase in the real interest rate’, he said. ‘This could have a negative impact on economic activity and thus on inflation.’

‘In this regard, we will need to monitor nominal long-term interest rates closely and act appropriately to maintain favourable financing conditions, in line with our December communication’, he added.

The concomitant steepening of the risk-free rate curve could indicate that markets expect the ECB to start tightening policy sooner than previously foreseen, he said.

‘While medium-term inflation expectations, as mentioned above, still remain well below our objective, and uncertainty about economic developments remains high, these developments highlight the importance of avoiding premature increases in nominal interest rates that could jeopardise the convergence of inflation to its medium-term objective’, he said.

The euro also needs to be monitored with respect to its potential impact on inflation prospects, he said. Although its strength has weakened in the last weeks, the appreciation that occurred since mid-2020 produced disinflationary pressures just when the area already faced historically weak inflation prospects, he said.

‘We have therefore emphasised at the Governing Council of the ECB that we will closely monitor exchange rate developments’, he said.

De Cos warned that a tightening of financing conditions in those countries that had less fiscal room to manoeuvre when the pandemic-related crisis began ‘could provoke a restrictive fiscal policy reaction, as we saw at some point during the previous crisis, which would seriously damage the recovery.’

European monetary authorities ‘stand ready to adjust all our instruments appropriately to ensure that inflation moves towards our objective in a sustained manner, in line with our commitment to symmetry’, he said.

Given the deteriorated economic outlook of late, based on available short-term indicators, and medium-term inflation prospects that fall significantly short of the ECB’s objective, ‘there is no room for complacency’, he said.

Notwithstanding the introduction of vaccines, the crisis will persist, and if public health measures to contain the pandemic must continue, ‘a further contraction in some countries or sectors cannot be ruled out’, he said.

The increase in HICP registered in the early part of this year reflected in particular ‘transitory factors’, he said.

‘The situation I have just described is therefore one of a fragile, heterogeneous and uncertain recovery in the euro area, where some of the downside risks identified only a few months ago to our central short-term scenario are materialising’, he asserted.