ECB’s de Cos: Incoming Data Confirming Our Expectations of Inflation; Growth May Surprise Negatively

16 October 2023

By David Barwick – FRANKFURT (Econostream) – European Central Bank Governing Council member Pablo Hernández de Cos on Monday said that the latest data had been consistent with projections for inflation but had possibly been weaker than anticipated with respect to growth.

In an interview with the Financial Times, a text of which was published on the website of the Banco de España, which he heads, de Cos said, ‘The incoming inflation data have basically confirmed our expectations for headline and, more importantly, underlying inflation.’

‘We have seen real yields rise, long-run inflation expectations decline and stock prices fall’, he continued. ‘Thus we have observed an additional tightening of financial conditions.’

The newest information pointed to weaker growth, he noted. ‘Indeed, based on our now-casting models, we cannot fully rule out slightly negative growth in the third quarter, which would be a mildly negative surprise as compared to staff projections’, he said.

Developments in the Middle East would on no account be favourable for confidence, consumption and investment, he said.

‘So I think our September assessment for our monetary policy going forward is even more valid today’, he said. ‘In any event, we should continue to emphasise that uncertainty remains very high, while following a data-dependent approach and remaining fully committed to meeting our target.’

With respect to reducing the size of the ECB’s balance sheet, ‘caution is in order’, he said, observing the existence of ‘a connection between increasing rates and reducing the balance sheet.’

Rates were the primary monetary policy tool, while quantitative tightening complemented the rate hikes, he said.

‘And our September assessment is based on the combination of both instruments’, he said. ‘Indeed, the ECB has reduced its balance sheet far more robustly than other central banks. If at any point we discuss changing the current path of balance sheet reduction, we will have to assess the degree of tightening provided by the combination of these two tools and to what extent such action would be compatible with reaching the inflation target in the medium term.’

That assessment would also have to take into account the further tightening of financial conditions lately, he said.

‘And then there is the important issue of PEPP reinvestments standing as the first line of defence against potential fragmentation in the transmission of our monetary policy’, he observed. Although there had hardly been any fragmentation in the last year, this could be thanks to the existence of the PEPP, he said.

‘In addition, the slower growth setting and the additional tightening imported from the US has to be factored in’, he added. ‘So having this first line of defence is to be welcomed.’

According to de Cos, higher long-term interest rates were due to ‘US market dynamics, and mainly by an increase in term premia, and passed through to other international markets due to the dominance of US bond markets.’

‘In any event, it has ultimately led to a significant increase in real rates in the euro area, particularly at the long end of the yield curve’, he said. ‘The implications may differ from when rates are driven up by, for example, the market suggesting that euro area inflation may be more persistent. This is not the case now.’