Exclusive: ECB’s Wunsch: March's Banking Sector Turmoil Could Have Limited or No Monetary Policy Impact

19 April 2023

By David Barwick – WASHINGTON (Econostream) – The turmoil that hit banking sectors in various global jurisdictions last month will not necessarily have any significant bearing on the monetary policy decision to be made by the European Central Bank in two weeks, according to ECB Governing Council member Pierre Wunsch.

In an interview over the weekend with Econostream (transcript here), Wunsch, who heads the National Bank of Belgium, characterised recent developments in Europe’s banking system as ‘comforting’, with confidence seen returning and ‘the idea that there would be a lack of trust in the system’ waning.

If in the US ‘it seems to be a question of not whether but rather to what extent’ the March bout of volatility leads to tighter credit conditions as banks seek to rebuild buffers, European banks, buttressed by continued robust liquidity and capital buffers, are not confronting such a necessity, he said.

‘So, I would certainly not exclude that the impact of what we’ve seen in the US and in Switzerland would be limited in the euro area, and even to the extent that there’s not an impact on our monetary policy’, he said. ‘I’m not saying it won’t impact, but the case where it doesn’t impact or has a very limited impact is certainly not to be excluded.

With lending data to be available to the Council by the May 4 policy meeting not likely to be negative, the size of any tightening move will probably be heavily influenced by core inflation, he suggested, notwithstanding the ‘good news’ of the recent decline in the euro area headline figure.

‘The fact that we have a reading of core at 5.7% with lower energy prices again confirms that our models tend to underestimate the inertia or persistence of core’, he said. ‘And if we have a high reading of core for April … then we would really be in a scenario where we need to do more.’

Indeed, ‘a high reading of core might at least push me to defend 50bp’, he said. ‘But if we were to have a surprise in the other direction, I think 25bp would also be a reasonable step. I haven’t decided yet whether I’m going to defend one or the other.’

Like a number of his colleagues, Wunsch, whilst avoiding the expression of any specific preference besides including both possibilities in the Council’s discussion, observed that the smaller option could be communicated with hawkish language or, alternatively, the larger one with a dovish tone.

The ECB in any case was not on the verge of another sequence of 50bp hikes, he readily confirmed.

‘Where market expectations are now, at 3.75%, looks to me like probably close to where we want to go, on the basis of what I know today’, he said. ‘Of course, there can be a surprise in one or the other direction. I would probably be open to both options and I’ll see what the data tell us.’

With inflation now running hotter in Europe than in the US, but – conversely - with the federal funds rate near 5% versus a deposit facility rate of a mere 3%, it was only realistic to entertain the possibility that the ECB ‘might have to go higher than the 3.75% currently expected by markets’, he reasoned.

‘I’m not saying that I’m defending that, because I’m very comfortable with the idea that it’s going to be meeting by meeting and data-dependent’, he said. ‘But the idea that we are very close to the terminal rate, I honestly don’t read that from the data.’

The argument that 350bp of tightening needed to be allowed to unfold its full impact was somewhat simplistic, he indicated. ‘[F]or the real economy, and for agents that have to take decisions on the basis of the real interest rate, I don’t see a lot of tightening, honestly’, he explained. ‘There’s clearly been tightening for financial agents, and that can have an impact at some point, but for investors and households, it’s not that tight.’

Although inflation expectations might appear well anchored, every negative inflation surprise would induce workers to demand more, meaning that ‘you’re going to have wage developments being incompatible with our 2% target for a while’, he said.

Given the risk of a dis-anchoring of expectations and the fact that reining these back in would no longer be relatively straightforward, ‘erring on the side of a robust rate increase that will keep inflation under control makes sense’, he said.

A pause in the tightening cycle could only be appropriate if, over a period of months, ‘we were to see core inflation going down at a significant pace, not like 0.1pp every three months’, he said. From today’s perspective, however, ‘as long as core is as sticky as it is and growing with a momentum of around 0.4% on a monthly basis, this is not compatible with our objective.’

Independent of the ultimate terminal rate, Wunsch was reluctant to endorse the view that the tightening cycle should, as some Council members have suggested, be over by the end of 3Q.

If nothing happens and everything develops as we thought, so if energy prices evolve in line with the projections and if there are no shocks that we failed to predict, then it’s likely indeed that it will be the case that we should be there by the end of summer’, he said. ‘But I don’t know.’

Ending from July reinvestments of maturing securities acquired by the ECB under the asset purchase programme (APP) ‘would be reasonable’ on the basis of current knowledge, he said. The likelihood that reducing the balance sheet meaningfully would take years would ‘take years in any case’ was ‘all the more reason to not wait too long’, he said.

Nonetheless, he flatly declined to support outright sales of assets anytime soon. ‘What can be discussed now is stopping reinvestments, and after the APP we still have the PEPP [pandemic emergency purchase programme]’, he said. ‘I’m not looking beyond this.’

The importance of proceeding ‘step by step’, he said, also ruled out for now a change in the guidance applicable to the PEPP, according to which reinvestment of principal payments would continue until at least the end of next year.

In general, Wunsch advocated remaining prudent with respect to QT. ‘I think if we go too fast on QT, we could be faced by some technical constraints that we had not seen but that could impact spreads’, he reasoned. ‘Why should we go for that? So, I think that the idea that we want to be on the safe side with respect to QT so as to preserve the quality of transmission is quite consensual.’

By the same token, he was unenthusiastic about QT becoming part of any potential policy compromise. ‘In principle one can always have that kind of trade-off, but I would not be pushing to do more on QT and less on rate hikes’ he said.

‘I don’t think it would be a healthy compromise, because we all agreed that we need to do QT, because our balance sheet is too big now compared to where it should be, considering that we have too-high inflation’, he continued. ‘If there were to be any kind of artificial trade-off or negotiations around QT versus rate hikes, I honestly don’t think this would be an interesting discussion.’