Rates To Remain Slightly Above Neutral Until 2025 or 2026, ECB’s Centeno Says

14 February 2023

Rates To Remain Slightly Above Neutral Until 2025 or 2026, ECB’s Centeno Says
- Centeno: When we stop hiking, we’ll be confident we’ve done enough for price stability
- Centeno: Don’t see upside risks to inflation, given December forecast revisions
- Centeno: ‘Inflation is going down faster than what we expected in December’
- Centeno: Somewhat uneasy about how fast ECB policy tightening has occurred
- Centeno: Observed euro area average wage increase can’t be considered 2d-round effect

By Xavier D'Arcy - LONDON (Econostream) - European Central Bank Governing Council member Mário Centeno on Monday suggested that interest rates would stay above neutral levels until 2025 or 2026.

Speaking at the London School of Economics, Centeno, who heads Banco de Portugal, stated that he did not see further upside risks to the inflation outlook in the euro area following the ECB’s upward revision to its projections in December.

Developments ‘may evolve in a way that may allow us to steer all this process of bringing inflation down, reducing the source of pressure on prices without requiring us to be very active in the medium term’, he said. ‘So, if we are able to do this and we are able to bring inflation down in 2024, 2025 to 2% with the measures that we are applying, then we will continue with this slightly above neutral rate … until 2025 or 2026.’

Should things take an unexpected turn, ‘we of course can always lower or [raise] the interest rate further in the future’, he continued. ‘But whenever we stop hiking the interest rate, it is because we are confident that inflation will go down to 2% without further action. Moving around with flipping interest rates over the cycles is not very productive to the credibility of the policy. So, we need to send signals that are consistent with this.’

Centeno did not specify exactly where he saw the neutral rate. It had been ‘really very close to zero’ for ‘quite some time’, he said, ‘but it's important to notice that probably this has now shifted a little bit up, which will be, if I may say, a good outcome, a consequence of this crisis.’

It was ‘pretty much obvious’ that ‘we are close to the natural rate’, he said.

Turning to prospects for inflation based on the ECB’s latest staff macroeconomic projections, Centeno said that ‘given what was in the outlook in December, risks now are at least much more balanced. And I don't see upside risks to inflation.’

In doing the projection exercise, Eurosystem staff had ‘charged the baseline a lot with inflation’, including ‘some big issues that we considered as risks before’, he said. On the other hand, the ongoing decline of commodity and energy prices had not been taken into account, he remarked.

‘We are lucky enough today that inflation is going down faster than what we expected in December’, he said. Looking ahead, though, the ‘big “if”’ remained the question of whether additional shocks were to occur, he said.

The economic cost of the ECB’s very rapid monetary tightening made him somewhat uneasy, he conceded. 'It's not as much the level of the interest rate that worries me today’, he said. ‘But it's how fast we did this; we never did that before.’

Given that the ECB's unprecedented series of rate hikes will take time to unfold their impact, policymakers need ‘to be ready and aware of the possible effects that this will create in the future in our economies’, he said.

‘It is possible that we don't see as much of a transmission of these short but intense periods of interest rate rises to the real economy’ because of certain buffers, such as accumulated savings, he said. Once these buffers are exhausted, he said, ‘everything will be much more clear’, though this would be ‘probably too late.’

This was one reason ‘to evaluate how much we need already, and how much is going to be needed’, he said.

Domestic pressures were not the cause of inflation in the euro area, and the ECB didn’t see ‘significant pressures’ coming from wages, demand or fiscal policy yet, he said.

There was no evidence of a wage-price spiral, and although wages were ‘now picking up’, most of the ECB’s indicators pointed to an average increase of euro area wages between 3% and 4%. ‘You cannot define this as a second-round effect’, he said.

The current communication of monetary policy was lacking, in his opinion. ‘We need to be better at communicating […] I think we kind of fail you and our citizens on that,’ he said, adding that ‘what I think is needed and we don't have yet very solid is a narrative, a narrative that helps us to anchor expectations in the medium term.’

The ECB should ‘tell people that at a given moment in time, after a period of tightening, the interest rate will go down', he said.