ECB’s de Cos: Can’t Say How Far We Will Have to Hike Rates to Achieve Our Objective

29 November 2022

By David Barwick – FRANKFURT (Econostream) – It cannot be stated at this point how far the European Central Bank will have to increase interest rates to restore price stability, ECB Governing Council member Pablo Hernández de Cos said Tuesday.

In an appearance before the Senate Budget Committee of Spanish Parliament, de Cos, who heads Banco de España, said that ‘[a]t this stage, the assessment of the Governing Council of the ECB is that ensuring that inflation returns to our objective will require additional interest rate increases.’

The rate hikes expected by financial markets when the ECB last updated staff macroeconomic projections in September ‘might not be sufficient to achieve the 2% inflation target’, he said. Even the September and October hikes of 75bp apiece have not taken the deposit facility rate, now at 1.5%, to what markets at that time expected in the medium term, he noted.

‘Given the considerable uncertainty, however, it is not possible to anticipate the extent to which we will have to raise interest rates to secure our medium-term inflation objective’, he said.

Future interest rate decisions, he said, would reflect economic developments, in particular ‘the size of the economic slowdown, including the increased likelihood of recession that we are currently observing’; the ‘considerable progress’ of previous decisions and the lag to which their impact is subject; potential second-round effects and inflation expectations, so far anchored despite ‘some incipient signs to watch out for’; and decisions pertaining to the balance sheet.

The speed of normalisation in part is a hedge against the risk of a disanchoring of expectations, he said.

With respect to second-round effects, ‘there is as yet no evidence that such effects are occurring, at least not across the board’, he said. Though wage agreements have picked up the pace, he said, ‘currently projected growth would be consistent with the 2% inflation target, once trend productivity growth is taken into account.’

Profit margins have likewise been largely moderate, he said, but the persistence of high inflation augments the danger of such second-round effects, he said.

‘Finally, interest rate decisions will have to take into account the decisions we take on reducing our portfolio balance, as this also has a decisive influence on financial conditions in the euro area’, he said, reiterating the intention of the Council to ‘set out the basic principles of this process at our December meeting’.

As before, de Cos urged that ‘the process of tapering our portfolio should be very gradual and predictable’, observing the uncertainty of the impact of QT, the worsening of fiscal conditions in the last years, the withdrawal of liquidity provided by the TLTROs, and the possibility that QT could aggravate financial fragmentation.

The global economy had been ‘losing momentum appreciably in recent months’ and the high inflation to which this is partly due is leading to a monetary policy response that in turn is ‘resulting in a significant tightening of global financial conditions’, he said.

Recent gas price developments should limit headline inflation’s upside during the winter, he said, but ‘the pass-through of past increases in energy price increases to the prices of other goods and services may still be incomplete, which will most likely contribute to continued high underlying inflation rates in the coming months.’

De Cos said that Banco de España’s most recent macroeconomic projections for the Spanish economy, published in October, had not changed very significantly since then.

‘In short, in the winter months, the current phase of weak economic activity is likely to continue, under the weight of the pressure that high inflation is exerting on household incomes’, he said. ‘Moreover, the recent dynamism of tourist flows from abroad, which have almost recovered to pre-crisis levels, may be affected in the short term by the effects of the upturn in inflation on the real incomes of potential tourists.’

‘From spring onwards, activity is expected to regain increasing strength, as a number of factors come together to boost activity’, he said, but ‘[t]he gradual strengthening of activity is not expected to be strong enough to allow a recovery to the pre-pandemic level of output before early 2024.’