Transcript of Interview with ECB Governing Council Member Centeno

28 June 2023

By Xavier D’Arcy – SINTRA, Portugal (Econostream) - Following is the full transcript of the interview conducted by Econostream on 27 June with Mário Centeno, Governor of Banco de Portugal and member of the Governing Council of the European Central Bank:


Q: There's been some very clear signalling that the ECB is going to hike by 25bp in July. Is a 25bp hike now a near inevitability?


A: Well, I am a big fan of keeping communication strategies as intact as possible. So we will speak in July. On the Governing Council, we all may have scenarios. Then, we also have the data points that are made available over time. We just got worrisome data for Europe as the big decline in PMIs in the manufacturing sector and also in the services sector. The services sector is getting close to 50, which is the contractionary line for PMI. The ifo data for Germany also came out yesterday, a lower figure and below expectations. Credit conditions have tightened significantly in the euro area as well. This is what one might expect from the current monetary policy stance. We interpret these developments and we take them on board, this is what was expected of us.

So, we better be careful about producing substantial statements about the future. Also, more importantly, this goes against the strategy; if we are data dependent, why do we need to keep announcing decisions before time? I don't see one single reason for that. We know what the market expects, but these are market expectations. Not our decisions. Otherwise, we will be replaced by the markets. We have our own concerns as a group, they are debated, they are drawn into the monetary policy statement. The monetary policy statement was completely empty of any references about future decisions, apart from a very clear statement of the common understanding of the Governing Council of the need to be persistent in the tightening process. And that's something that I fully agree with. We need to bring inflation down to 2%,  but we are not targeting the inflation rate in September or October 2023. We are targeting medium-term inflation. Inflation is coming down. We say that headline inflation has been 'too high for too long'. It has been too high. The 'too long' part has to be put in context. The arithmetic of the inflation path is very simple. From the moment in which headline inflation exceeded 2% to its peak, it increased by 0.018 percentage points each day. Since the moment it has peaked in October 2022, it has come down at a faster pace, 0.021 percentage points per day.


Q: Do you think there's a chance that we could be underestimating the speed of disinflation? We've seen 2025 inflation forecasts bumped up to 2.2%. Do you think we could see it go back to 2% very quickly?


A: Inflation is a symptom, it's not the problem. The problem lies behind the scenes. Inflation reveals that something is not going well in our economic system. It reflects decisions of millions and millions of people and firms every day in our economies. And inflation has started to come down again, as fast as it went up. It took longer than average to reach the peak of inflation this time, because there was a succession of shocks, it was not a single shock at a specific moment.  All those shocks have already been reversed. In 2023, we have negative year-on-year changes in all commodity prices. - In 2022, we had a significant terms of trade loss in Europe. We observed already a reversal and expect it to completed in 2024. No one was expecting that a few months ago! No one. Everyone was expecting a slower recovery in terms of trade. External trade deflators are negative. So why should it be the case that this reversal of shocks together with the largest hike in the shortest period ever by the ECB will not have an impact both on inflation, which is the symptom, and on the economy, which is where the real problem is? I don't  see one reason for that not to happen; it is occurring.


Q: I think maybe the answer for that, for some people who might disagree with what you just said, lies in the labour market. What is your assessment of the contribution that labour market developments are currently making, how much of an upside risk do wage developments pose?


A: We talk a lot about labour hoarding. Given that firms are not irrational agents, if they hoard labour, it is because they think the shock is temporary. That's the only possibility because (idle) workers are a cost. They not only hoard labour, they also increase wages. Often, economic analysis make a basic mistake, which is to evaluate aggregate productivity and ignoring composition effects. Take a labour market that is creating jobs, usually with wages below the average. This labour market is not becoming less efficient. I will say, it's the opposite. A big problem with sclerotic labour markets in Europe was the difficulty to create jobs at the low end of the wage distribution, causing for example long term unemployment. This implied that the service sector in some well-known countries in Europe were really inefficient because they were relying on a range of wages that did not allow those markets to operate efficiently. We are now creating a lot of jobs in Europe: 8 million jobs since the worst moment in COVID. Half of those jobs were filled by workers that were born in a country different from the country in which they are working. Lots of mobility! It never happened before in Europe. Also new hires are much higher today than before COVID, another sign of the dynamics of our labour market. And I am sure this is delivering a more efficient labour market than before. We should not worry about productivity levels at the aggregate, because there is a (healthy) composition effect.


Q: How persistent is this effect, though, I'm wondering, in the face of tightening of monetary policy, I talked to a lot of other central bankers, and they seem to think that we will have the Goldilocks scenario that the labour market will remain strong, and we'll get inflation back to target with no return of slack?


A: I don't know if that will be possible at the end of the day because we have to go step by step. What I'm trying to say is: Look, from what we observe, today in Europe, we must be very happy. Because for the first time ever, the European labour market looks much more fluid, compared with previous moments in which we see it as being sclerotic, not creating jobs, showing signs of hysteresis. We are not yet probably at our most efficient position, but we are converging. But if the situation deteriorates, the change will also be very large; in more fluid labour markets incur larger swings.


Q: So we could be underestimating that pass-through maybe a little bit?


A: Yes. That's for sure. That's why we need to look at 18 months’ time and not today, the pass-through of 400bp increase in the interest rate will be huge. The European did not become insulated from financial tightening. It's not yet fully revealed. It’s working behind the scenes. And it may come abruptly because firms do not implement “half” investment projects or families can pay only half of their mortgage instalments. This is all highly non-linear.


Q: Do you foresee a scenario where you can stop, you can pause with these projections remaining as they are, showing inflation of 2.2% in 2025? Might the favourable development of other data maybe be enough to warrant a halt?


A: The scenario may be optimistic in terms of GDP and consequently pessimistic on inflation. If the economy doesn't grow as much as expected, inflation will also reduce faster than expected. But my most likely scenario for now is - and I feel confident with it so far - the baseline scenario of the ECB staff; we may reach an end to the inflationary process without causing major disruptions to the economy.


Q: By the baseline scenario of the ECB staff you mean?


A: Look, 2.2% for inflation in two years' time in our projections, and we need to be very humble about standard errors. So this can either be 2.5% or 1.7%. But the central point is 2.2%. And 2.2% is, for that matter, on target.


Q: Well, I think there's disagreement about that. Right?


A: I remind people that the integral in one point is zero. Therefore, the probability of getting 2% is zero. We are flexible, right? Because we allow for temporary deviations above 2%, as much as for temporary deviations below 2%, it is in our monetary policy strategy, without big stress. So how can I be stressed about a projection that says that in 2025, in two years’ time, inflation is 2.2%? I really don't get it.


Q: One thing that you did mention in May was that there could be rate cuts at some point in 2024. I think the market is now pricing in September 2024. Is that something you'd still stand by? What would be the necessary conditions then for a cut? Would you have to see like the projections showing it below 2% at some point?


A: At that point, we will be able to take a stronger view on what is the neutral rate. Because before the inflationary process, we were quite depressed about the level of the neutral rate, and it is the neutral rate that says how much tightening there is. And the estimates before the inflationary process were in the range of 0.5% to 2%. Well, I don't see many structural reasons for the neutral rate to have changed after the pandemic. Because this was a negative supply shock. This has nothing to do with the with the nature of our economic system, in Europe. Demography is not better technology is not better. Our tastes, our consumer preferences, did not change materially. I don't know why we should have a higher neutral interest rate. But when we pause, we must explain how much tightening there is and for how long we expect this tightening to continue. And again, if we believe the baseline scenario, and if it materialises, what is embedded in this baseline scenario is the futures for the EURIBOR. And the futures have a reduction in rates in 2024.


Q: So, a cut is not completely unfeasible?


A: That's what was fed into the forecasting model by the ECB staff. And it is compatible with a reduction of inflation to 2% in the medium term. I'm not pledging anything because it's too far yet. We will collect some information in due time. But it is important for us, when we pause, to be as predictable as possible, because predictability is key to reduce uncertainty and to increase confidence. If, after the summer, we are not able to be more predictable and if we keep playing this game of trying to announce something that we don't want to announce, this only creates noise and anxiety in people. Every time people see the decision-maker going on word games with future decisions, it creates anxiety.


Q: I mean, is it feasible that when we do reach that point, when we finish hiking, that you can then really say: Okay, this is the terminal rate, we've arrived?


A: Yes. That is my goal. I have been saying that the suppliers of patience in our society are public decision makers., We need to create a safe environment for agents to take decisions, a predictable environment. If you look too anxious, like: 'Oh, my God, this is not going down too fast.' what will people think?


Q: I mean, I guess that's also inevitable as you reach as you reach the end of it, that these differences become a bit more visible, it's been very easy up until now.


A: I've been one of the most vocal people claiming for Europe to raise the stakes of its social contract. Europe is the place on Earth, in which social partners meet most often. We are the world’s source of social capital. We have it, we need to use it. To kind of sort out a coordination failure that may exist in these periods of inflation. And now is the time to use this structure, this social capital, to bring unions, employers, governments together, with monetary policy decision makers as well, because we are also part of this world. To come together, and to understand that myopic behaviours today are very costly into the future. If I decide to increase wages, one percentage point today, or profit margins one percentage point today, I may be trying to solve my own problem as a worker or as a firm, but I'm causing an externality on everyone else. If this prevents inflation to come down, then monetary policymakers need to continue to increase interest rates. And, make no mistake, we will do it. But increasing interest rates will be costly to the entire society. There is a potential for further coordination.