Exclusive: ECB’s Centeno: ‘We Are Probably Close to Neutral Levels … 75BP Is Not a Norm’

30 November 2022

Exclusive: ECB’s Centeno: ‘We Are Probably Close to Neutral Levels … 75BP Is Not a Norm’
- Centeno: If Council ‘sees the need to take policy rates above neutral levels it will do so temporarily’
- Centeno: ‘Very important to underline that any rate hikes above neutral levels are supposed to be temporary’
- Centeno: Rates now closer to normal, but ‘this is no guarantee that further steps are dispensable’
- Centeno: ‘A decision completely aligned with market expectations is not guaranteed’
- Centeno: ‘Adding more predictability and the rationale to our decisions will be key’
- Centeno: ‘Financing conditions are no longer very accommodative’
- Centeno: ‘Our decisions cannot be compared, in size, with those of the Fed, as conditions differ substantially’
- Centeno: Key principles to reduce APP portfolio should exclude any resurgence of fragmentation

By David Barwick – FRANKFURT (Econostream) – Interest rate hikes of 75bp are not a norm and if the European Central Bank takes official borrowing costs in the region to above neutral levels, this can only be a temporary situation, ECB Governing Council member Mario Centeno said Tuesday.

In an interview with Econostream (transcript here), Centeno, who heads Banco de Portugal, said that euro area interest rates were probably approximately neutral at this point, but that having drawn closer to more normal levels did not necessarily mean that the ECB wouldn’t still need to implement additional rate hikes.

When the normalisation process began, ‘we were clearly far away from “normal” levels of interest rates’, he said. ‘Since several steps have already been taken, it is natural to consider that those ‘normal’ levels are drawing nearer. Still, this is no guarantee that further steps are dispensable.’

Though there is uncertainty concerning where neutrality lies in terms of interest rates, ‘we are probably close to neutral levels’, he said. ‘If going forward the Governing Council sees the need to take policy rates above neutral levels it will do so temporarily, as in the long run policy rates should return to neutral levels, those consistent with having inflation at target.’

The decision to be made at December’s monetary policy meeting requires additional information, including the updated macroeconomic forecasts, he said. ‘But it is clear that 75bp is not a norm, and that our decisions cannot be compared, in size, with those of the Fed, as conditions differ substantially in both economies.’

The markets and the ECB can have different data sets, ‘and, even if equal, it can be incorporated differently’, he said. ‘Therefore, a decision completely aligned with market expectations is not guaranteed. That is not our mandate.’

As to whether ECB President Christine Lagarde’s reference on October 27 to ‘substantial progress in withdrawing monetary policy accommodation’ was meant as a dovish signal, Centeno suggested that instead of ‘focusing on being hawkish or dovish in tone, we must understand that tightening is underway, that households and firms feel it, and that the ECB sent a clear signal on the substantial progress made towards interest rates compatible with price stability.’

‘Adding more predictability and the rationale to our decisions will be key, as much as seeing inflation converging to 2% in the medium term, as markets currently do’, he added.

Asked how he regarded the possibility, voiced by at least one of his peers as well as some private banks, that the ECB might need to cut rates again as soon as next year, Centeno didn’t dismiss the idea categorically, focusing in his answer on the ideally transient nature of interest rates above neutral.

‘Going forward, the Governing Council will continue to decide if and when further hikes are needed’, which ‘implies taking interest rates to neutral levels, or, if needed, temporarily above neutral levels’, he said. ‘It is very important to underline that any rate hikes above neutral levels are supposed to be temporary. … A permanently higher level of interest rates above neutral rates is only consistent with inflation above target over the long run!’

‘In any case, if the risks to price stability change and according to the information available at any time the ECB judges that cuts to the policy rates are needed to counter downside risks to price stability, that will be the course of action’, he said. ‘This will be consistent with our mandate and as such no credibility issues would prevail.’

Observing that the ECB’s last staff forecasts envisaged euro area 2024 HICP at an average 2.3%, Centeno noted that HICP had gone on to surprise on the upside, but that most commodity prices and in particular those of gas had declined significantly.

‘The range of European gas suppliers widened substantially over the past months, as predicted by economic theory, but the speed and breadth of this process was largely unanticipated’, he commented.

As for the economy, the region’s growth was likely to slow yet more in this quarter and the next, he said. The likelihood of recession had mounted, and this was ‘an important aspect to be taken into consideration’ by the ECB, along with, on the other hand, the welfare costs of inflation, he said.

Turning to monetary policy transmission, Centeno highlighted the importance of the mechanism’s proper functioning in order to achieve price stability and said that the ECB should avoid ‘[u]nwarranted effects on financial markets and on agents’ confidence’. The fact that normalisation had so far entailed no resurgence of fragmentation he attributed also to the ‘safety net’ of the ECB’s Transmission Protection Instrument (TPI).

Normalisation had however led to tighter financing conditions, so that these ‘are no longer very accommodative’, he said.

With regard to quantitative tightening, Centeno reminded that the policy rates remained the ECB’s primary tool. QT ‘could be complementary’ or ‘perhaps also a substitute at some point’ to rate adjustments, he said.

The key principles to reduce the portfolio of assets acquired under the APP would be discussed next month and ‘should certainly guarantee that there is no resurgence of fragmentation and perhaps address the shortage of certain safe and liquid assets’, he said. ‘When the time comes to start a much-needed reduction of our balance sheet, we need to be sure that we will be preserving financial stability, as a way to preserve the transmission mechanisms of our monetary policy.’

The repayment by banks of TLTRO III funds would only help the balance sheet reduction ‘somewhat’, he said. ‘In any case, the resulting reduction in excess liquidity would remain well above the level at which money market interest rates would be affected.’