ECB’s de Cos: Russian Invasion Could Raise or Lower Mid-Term Inflationary Pressures

15 March 2022

By David Barwick – FRANKFURT (Econostream) – The European Central Bank is taking into account the opposing medium-term inflation impact of Russia’s attack on Ukraine, with an increase in the risk of second-round effects on the one hand and the potential for diminished price pressures due to weaker economic developments on the other, ECB Governing Council member Pablo Hernández de Cos said Tuesday.

In a speech at a breakfast meeting with the business sector, de Cos, who heads Banco de España, said that the decisions taken at the Governing Council’s monetary policy meeting last week ‘balance the various risks to our price stability objective that arise in the current environment.’

‘…the short-term inflationary effect of the conflict increases the likelihood of the emergence of second-round effects and thus of the pass-through of inflationary pressures to the medium term’, he said.

‘Conversely, the war will have a negative impact on growth through a deterioration in real household and corporate incomes and an increase in uncertainty, which could be very significant, particularly in the short term and in a context in which the euro area economy is still far from its potential level’, he said. ‘Such a negative impact could reduce inflationary pressures in the medium term.’

The Council expects in any case that inflation would decline gradually and then stabilise near 2% in 2024, a forecast supported by various measures of long-term expectations, he said.

While having reduced the 2Q monthly purchase volumes of the asset purchase programme from the amounts anticipated in December, what the ECB does in 3Q ‘will depend on the evolution of the economic outlook and our assessment of it’, he said. ‘At the same time, given the extraordinary uncertainty we are experiencing, we emphasise the data-dependent nature of our decisions and increase flexibility and optionality in the use of instruments.’

If incoming information indicate that medium-term inflation prospects will prove sustained in the absence of net asset purchases, these can end in 3Q, he said. ‘However, should the medium-term inflation outlook change and should financing conditions be inconsistent with continued progress towards our 2% objective, we stand ready to review the net asset purchase plan in terms of both amount and duration’, he said.

As for the modification to the wording of the ECB’s forward guidance, the change ‘means maintaining the sequential process by which we intend to adjust our instruments, but it widens the time lag between these two events: the end of net purchases and the point at which we start to raise our interest rates’, he said.

‘And this increases the flexibility with which we can execute our decisions in such an uncertain economic and geopolitical context’, he added. ‘For its part, the gradualness of the interest rate adjustment shows the Governing Council's commitment to avoid abrupt adjustments in monetary policy instruments.’