ECB’s de Cos: To Be in Better Position to Determine Proper Policy Path With March Forecasts

15 February 2023

By David Barwick – FRANKFURT (Econostream) – The European Central Bank will be better able to decide how monetary policy should evolve with the benefit of updated inflation forecasts available in March, Governing Council member Pablo Hernández de Cos said Wednesday.

In a speech at a business association in Madrid, de Cos, who heads Banco de España, noted that the Council would ‘benefit from a new round of ECB staff macroeconomic projections’ next month. ‘We will then be in a better position to judge the most appropriate policy path, in a manner consistent with our data-dependent approach’, he said.

Although updated forecasts were lacking at the Council’s meeting two weeks ago, the ‘wealth of information’ still at the ECB’s disposal ‘led us to assess the risks to the inflation outlook as being more balanced, especially in the near term’, he said.

In conjunction with market- and survey-derived expectations of 50bp hikes in February and March and of a terminal rate of some 3.47%, de Cos said his conclusion two weeks ago was that the risk-free forward curve ‘could be seen as compatible with a return of inflation to the 2% target in the medium term.’

The Council’s policy decision and subsequent communication followed from this, he said, citing also the intention to hike by 50bp next month and ‘evaluate the subsequent path of our monetary policy’.

Overall, he said, ‘recent data on euro area inflation and some of its key determinants are somewhat encouraging, but the overall situation still requires caution.’

Among the determinants playing ‘a crucial role’ in the ECB’s ‘future policy path’ was the extent to which inflationary shocks, negative or positive, influenced core inflation, he said. Experience suggested that despite the easing of gas prices, the previous increase could continue to drive core in the short term, he said.

‘However, if the significant reduction in gas prices continues, it should be expected to gradually begin to trigger reverse transmission effects’, he said. ‘Consequently, at the current juncture, we could well be at some sort of crossroads, where the lagged effects of the past increases in commodity prices would still be present, but diminishing, and the first effects of the most recent decreases would be emerging and on the rise.’

Related to this, de Cos observed that the withdrawal of fiscal measures could also promote inflation persistence, calling this ‘the main reason why our December projections revised inflation upwards in 2024 to 3.4%.’

To the extent those measures are price ceilings, the magnitude of their impact depended on the size of energy price increases and cheaper energy could mean price ceilings do not take effect, he pointed out.

In this case, ‘the downward impact of these measures in 2023 would therefore be lower and, subsequently, the upward impact of their reversal in 2024 would be lower as well’, he said.

Wage developments were ‘another key determinant’ of future inflation, he said. Current indications are that the ECB’s December projections in this respect remain valid, he said, but given labour market tightness, ‘we should monitor wage and mark-up development to identify the potential emergence of second-round effects on inflation.’

Given the competing nature of China-related developments’ ramifications for inflation, de Cos concluded that ‘[a]ll in all, it is difficult to disentangle the net effects of all these factors on inflation and close monitoring will be needed.’

European economic resilience was also an open question, he indicated. The war waged by Russia against Ukraine was ‘still a major source of uncertainty’, and it was not entirely clear what would drive growth ahead, he said.

‘Therefore, we need to continue to monitor domestic demand patterns, which will be key to modulating the convergence of inflation towards our target’, he said.

Echoing remarks earlier in the week by his Portuguese counterpart, Mário Centeno, de Cos voiced uneasiness about the potential for the ECB’s rapid policy normalization to have ‘non-linear effects on the economy.’

Information derived from the share of fixed-rate mortgages and from banks’ slowness in passing on rate hikes to retail depositors ‘might point to a slower transmission of monetary policy than in the past’, he said. Yet other data suggest the opposite, making it ‘crucial that we monitor how all these elements may affect monetary policy transmission in the next quarters’, he said.