ECB Insight: de Cos Sets the Stage for Worrying Not Just About Risk of Doing Too Little

15 February 2023

By David Barwick – FRANKFURT (Econostream) – European Central Bank Governing Council member Pablo Hernández de Cos’ latest remarks are a reminder that the ECB is not going to hike by 50bp forever and that March, whilst probably not the time to decelerate, could be the right moment for authorities to start giving more consideration to the increasing risks of doing too much too fast.

De Cos, who heads Banco de España, is appreciated by ECB observers as a cautious and thoughtful commentator who, while essentially dovish, has a healthy respect for the value of a united front and less often issues policy prescriptions with the directness of many of his counterparts on either side of the aisle.

Consider other recent interventions by de Cos. On January 11, he dutifully reiterated then-standard ECB messaging about hiking significantly at a sustained pace. To be sure, he also said that given the prevailing ‘extraordinary uncertainty’, the ECB would ‘continue to be data driven and will follow an approach where decisions are taken at each meeting.’ But on no account was he breaking ranks.

No change was seen when, five days later, he again endorsed the intention to hike significantly at a steady pace whilst reminding that the ECB would at every meeting go where available data led it.

Even on January 22, for de Cos, ‘[t]he most important message is that we have not reached the end yet.’

Three weeks on, with some non-monetary policy speeches and another 50bp hike in the interim, his tone has changed. The change is not dramatic, but given his relative preference for understatement, it is unmistakeable.

In his speech on Wednesday, he backed the Council’s December and February decisions, but made clear that as of the meeting two weeks ago, ‘the risk-free forward curve – together with all the other factors influencing markets’ and experts’ inflation expectations – could be seen as compatible with a return of inflation to the 2% target in the medium term.’

That, he indicated, reinforced the importance of carrying through with what everyone understood was coming, lest the ECB put at risk the ground gained on the strength of December’s hawkish turn. This includes a third 50bp hike next month, which we see him as willing to support in the interest of cementing hard-won progress.

It is harder to see him, already on the basis of the above remarks from today, as inclined to continue favouring large policy moves beyond March a priori. Rather, he seems very ready to return to decision-making that doesn’t merely pay lip service to a data-driven, meeting-by-meeting approach.

Indeed, he notes explicitly that the updated staff forecasts due next month will leave monetary authorities ‘in a better position to judge the most appropriate policy path, in a manner consistent with our data-dependent approach.’

Even just up to this point, reading between the lines, de Cos seems to be gearing up for a new phase of setting monetary policy, one we would see as a potentially brief period of fine-tuning, with the discussion increasingly considering a less lopsided view of the balance of risks.

His subsequent exposition of what he calls ‘factors that I see as playing a crucial role … in our future policy path’ lends credence to this interpretation, even if he is characteristically reticent about making precise policy prescriptions.

De Cos lists five of these factors, starting with the extent to which inflationary shocks influence core inflation. Despite the easing of gas prices, the previous increase could continue to drive core in the short term, he concedes. On the other hand, if gas prices maintain their slide, this would lead to ‘reverse transmission effects’, he also pointed out.

The euro area could thus be ‘at some sort of crossroads’, with the way forward characterised mainly by the increasingly evident impact of cheaper commodities, he said.

He finds reason as well to be more sanguine than many of his peers about the contribution to inflation persistence of fiscal policy measures, arguing that, as some of these took the form of price ceilings, energy price falls might mean that they never take effect.

Then there is the exchange rate, of so little help in the first part of last year. De Cos put this in the ‘need to monitor’ category, but not without noting the potential for the euro’s recent appreciation to dampen consumer price growth.

As for wage developments, these are not currently inconsistent with Eurosystem forecasts, he found, though he duly observed that tight labour markets might feed into pressure to recoup real purchasing power.

‘Thus, we should monitor wage and mark-up development to identify the potential emergence of second-round effects on inflation’, he said.

De Cos’ relative lack of concern in this area is perhaps most striking. It is worth remembering that for many policymakers, it is precisely the worry about wage developments that motivates support for tighter policy.

‘The largest upward risk to core inflation is a further increase in wage growth’, Dutch National Bank Governor Klaas Knot affirmed last week, citing various reasons to suspect the risk would materialise.

China’s reopening was another case of the need for ‘close monitoring’, according to de Cos, but here, too, he was anything but alarmist, enumerating the pros and cons and concluding 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.’

He continued in the same vein through euro area economic resilience and monetary policy transmission, in both cases calling for monitoring but somewhat more open to the idea that the respective factor could cooperate with efforts to restore price stability rather than contribute to inflation persistence.

It seems scarcely worth arguing that de Cos has moved on inwardly from the mindset of a month ago, namely in the direction of, if not declaring ‘mission accomplished’ in terms of having reached the terminal rate, at least strongly doubting the need for or wisdom of further boldness.

Again, we think he is likely to support 50bp in March, considering one more such move consistent – absent good reason to the contrary - with locking in recent and significant progress toward restoring price stability. But as of today and pending incoming data, we doubt he would readily sign on next month to a further continuation of December’s course.