Exclusive: ECB’s Stournaras: Misguided to Hike Rapidly at the Risk of Needing to Backtrack Soon

31 August 2022

- Stournaras: ‘Should err on the side of caution rather than on the side of speed’
- Stournaras: Unwarranted wage growth would justify aggressive hiking, but wage growth ‘okay’
- Stournaras: Would like monetary policy to normalise without destabilising output
- Stournaras: ‘Don’t think we’re anywhere close to actual action’ with respect to QT
- Stournaras: QT now ‘could make the situation much more difficult for the real economy’
- Stournaras: TLTRO redemptions to bring ‘a lot of shrinking’ to ECB balance sheet

By David Barwick – ALPBACH, Austria (Econostream) – European Central Bank Governing Council member Yannis Stournaras on Tuesday acknowledged the clear need for further euro area monetary policy normalisation, but argued strongly against any approach not characterised by gradualism and thus rejected rate moves of unusually large magnitude.

In an interview with Econostream during a conference in Austria, Stournaras, who heads the Bank of Greece, did not hesitate to endorse the view that the situation warranted further increases in official borrowing costs until reaching the neutral rate, whilst urging policymakers to keep in mind that gathering economic storm clouds augured at least a slowdown if not perhaps a full-blown recession.

This is why I believe in normalising policy rates only gradually, because in my view it is misguided to hike to a very high level at the risk of then having to backtrack and start cutting rates’, he said. ‘A gradual approach is the only appropriate one.’

That overly aggressive hiking could quickly backfire, costing the ECB credibility and creating avoidable economic harm, was far from the only argument in favour of going strictly ‘step by step’, he said. Extremely elevated uncertainty and the exclusively supply-side origin of current European inflation also warranted ‘being careful and prudent’, he said.

Stournaras agreed that the Transmission Protection Instrument (TPI) approved by the Governing Council at its July meeting was ‘a powerful instrument’ that mitigated earlier concerns about an adverse market reaction to monetary tightening. However, he made clear that the new tool did not reconcile him to a step of 75 basis points.

‘I don’t want to pre-empt our discussion in the Governing Council, but I prefer to stay gradual and flexible’, he said when asked about a hike of that magnitude. ‘After all, gradualism, optionality, flexibility are the three principles that guide our monetary policy changes.’

Asked outright what could induce him to change his mind about the appropriateness of 75 basis points, Stournaras said that wage growth was for him the key medium-term indicator.

If wage growth were to become economically unwarranted, then I would say, “Yes, okay, we need to act aggressively”’, he said.

He politely declined to subscribe to the view of some colleagues that gradualism had to take a back seat to incoming data, arguing that it was incumbent upon the central bank not to undercut economic growth more than high energy prices were already doing.

‘I would like monetary policy to be careful, to contribute to the normalisation of policy rates, okay, but without destabilising output’, he explained. Admittedly, he said, central bankers faced a dilemma, but the only choice was to make clear to the public that aggressive monetary tightening was simply not the proper response to supply-side shocks.

Circumstances such as dis-anchored inflation expectations or pronounced second-round effects might warrant more robust policy action, he said, but these were not currently apparent. Wage growth at the level of the euro area was ‘okay’, and various market- and survey-based measures showed expectations near the ECB’s medium-term price stability target of 2%.

‘So, that’s another argument why we need to be careful and not rush with too-large changes in rates’, he said.

Whatever the Governing Council decides next week is the appropriate size of the anticipated rate hike, Stournaras said he would not exclude that it would also take the opportunity to adjust the corridor between key interest rates.

Ideally, this corridor would be symmetrical as in the past, he said. However, the ECB had ‘more immediate challenges’, and there was ‘no need to deal with this now’, he said.

Similarly, while a change to the tiering system applied to the remuneration of reserves was also coming eventually, this was ‘not a point of urgency at this point’, he said, and could be delayed a little while yet.

It was also still soon, he said, for a discussion about how to reduce the ECB’s balance sheet, swollen by years of massive asset purchases.

‘I think it’s too early’, he said. ‘Because if you add quantitative tightening to policy normalisation, that could make the situation much more difficult for the real economy.’

Even if the ECB started preliminary discussion of the subject of QT, which he did not rule out as soon as next week, ‘I don’t think we’re anywhere close to actual action on that front’, he said.

After all, he reminded, the ECB’s balance sheet would be subject to downsizing in any case, with the TLTRO redemptions in particular set to contribute ‘a lot of shrinking.’

This effectively amounted to monetary tightening, of which there had been a lot since last December, he said. Asked whether he would still describe financing conditions as very accommodative, he replied, ‘They’ve become tighter. They’re accommodative but they’ve become tighter.’

Still, he agreed that the euro area remained far removed from a financially restrictive environment. It was essential that this remain the case for now, he urged, also given that the only durable solution to the present energy-driven inflation was ‘huge investment in renewables.’

‘If we make financial conditions difficult, this investment will not take place’, he said. ‘All these arguments make me believe that we should err on the side of caution rather than on the side of speed in the monetary policy adjustment.’