ECB’s de Cos: De-Anchoring of Inflation Expecations Would Be the ‘Worst-Case Scenario’
19 September 2022
By David Barwick – FRANKFURT (Econostream) – The worst thing that could happen from the perspective of monetary policy would be a de-anchoring of inflation expectations, European Central Bank Governing Council member Pablo Hernández de Cos said Monday.
At a forum in Almería, Spain, de Cos, who heads Banco de España, said that the ECB ‘will continue to normalise monetary policy, at a pace and to a magnitude that will depend on the materialisation of risks to our medium-term inflation objective.’
Of those risks, at least two are critical for the ECB, one being the potential de-anchoring of expectations, he said. ‘A materialisation of this risk would be the worst-case scenario, because it would affect the price and wage decisions of firms and workers in the present’, he said. ‘This would push inflation even higher and make it even more persistent, forcing monetary policy to take even more forceful action, with consequent damage to activity and employment.’
So far there is no evidence of such a de-anchoring, ‘but there are some incipient signs to watch out for’, he said, noting that the ECB’s own monthly Consumer Expectations Survey most recently indicated median 3-year expectations of 3% HICP, versus a bit above 2% in early 2022.
The ECB will remain ‘extremely vigilant’ about this risk, and forestalling its materialisation helped motivate the recent frontloading of policy moves, he said.
Possible second-round effects were the other key risk, he said. ‘This is a scenario to be avoided, as it would make inflation much more persistent and thus make the feared de-anchoring of inflation expectations more likely’, he said.
At least on a broad front, such effects cannot be seen yet, he said. ‘However, to the extent that the current high inflation persists, the likelihood of such second-round effects increases’, he added.
De Cos said that the size of the looming hit to growth and how this affected wages and profits would heavily influence inflation prospects and thus monetary policy.
‘Ultimately, our forthcoming decisions will be based on the new information available to us and its implications for the achievement of our inflation objective over the medium term, consistent with the "meeting-by-meeting" approach we have adopted’, he said. ‘In any event, interest rates should reach a level that allows us to ensure a progressive convergence to our medium-term inflation objective, and the speed at which we reach that level will be conditioned by the same objective.’
Market interest rates have increased significantly, which ‘tightening of financial conditions will help to contain inflationary pressures’, he said.