TRANSCRIPT: Interview with ECB Governing Council Member Centeno on 5 January 2024

9 January 2024

By Isabel Teles – FRANKFURT (Econostream) – Following is the full transcript of the interview conducted by Econostream on 5 January 2024 with Mário Centeno, Governor of Banco de Portugal and member of the Governing Council of the European Central Bank.

Q: Governor, the ECB last month decided to keep its interest rates unchanged at the current level for the second time in a row. Would you agree that beyond any reasonable doubt, we've reached the terminal rate?

A: The answer is yes, based on current data. We decide meeting by meeting and are always data-dependent, but the baseline now tells us that we have already increased interest rates sufficiently to make a substantial contribution to inflation converging to 2% in the medium term. In fact, since the end of 2022, our inflation forecasts for 2025 have been consistently very close to 2%, which means that inflation rates are very strongly anchored at our medium-term objective. If new shocks in any way disturb the evolution of prices, which we do not expect, then we must talk again.

Q: During Banco de Portugal’s press conference after the release of the December 2023 Economic Bulletin, you said that the question was no longer whether there will be cuts, but when they will happen. When would it be appropriate for monetary easing to start, based on what we know now?

A: That's the big question. Since decisions are made meeting by meeting based on available information and we are no longer relying on forward guidance, I can’t answer when, but I can make a slightly more qualitative analysis and say that the most recent developments on inflation and the economy have obviously brought the moment of easing closer to us. We expect in the next quarter further confirmation that inflation is on a path of convergence to 2% in the medium term. The absence of such confirmation would bring new difficulties both for monetary policy and citizens, difficulties that we very much hope to avoid. The decision to keep nominal rates steady for the moment is appropriate and we will decide when to cut them sooner than we thought until recently.

Q:  It was expected, as stated in the ECB’s last monetary policy decision, that inflation in the euro area would pick up temporarily. Euro area’s December HICP was 2.9%, indeed an increase from November (2.4%) and the same figure as in October. Given the increase in inflation was not greater than expected, does that reinforce your belief that easing would be possible sooner?

A: Yes. These are good news, but to me not surprising; the pick-up was smaller than the market expected and less than the base effects incorporated in the forecasts. As I said, we will remain data-dependent, which also means that we must incorporate recent data on inflation and economic activity in forthcoming monetary policy decisions.

Q: Did the ECB go too far with its policy tightening, and do you agree that putting things on hold all the way until 2024 wage developments are clearer – next April or May – is excessively long under the circumstances?

A: I don't think we have to wait until May to make decisions. I think we must, in each of the next meetings, take the decisions that best accommodate the objective of bringing inflation back to 2%. I have a clear vision about the labour market, which I recently published on the website of Banco de Portugal. I don't see any sign that second-round effects on wages have materialised or will materialise or that wages will put additional pressure on prices. Real wages in the euro area are still below the pre-inflationary period. Unlike the USA, where they have already recovered, this has not happened in the euro area. It is natural that real wages will recover, in fact it is even desirable that real wages recover soon. A pick-up in real wages is an all-natural process. We must keep in mind that in this recovery, what is truly important are productivity gains. We must have productivity gains associated with wage gains. The pressure variable for inflation is not wages, but unit labour costs. This is why productivity is important in this context.

Q: Even Isabel Schnabel now refuses to rule out a rate cut in the first half of 2024. Once easing has started, do you think it will proceed at a pace like that of the preceding tightening?

A: It is a decision that we will make meeting by meeting and with all the data available, but with a logic of economic stability and having in mind that we target medium term inflation, and that inflation is no longer too high, even if it still has to come down. On this issue of pace, let me take the opportunity to mention a fact: inflation rose more slowly than it has been falling. In other words, the descent has been faster than the climb. And this means that inflation was a more temporary phenomenon than many believed a few months ago. And this has been true for both headline and core inflation indicators. The temporary nature of inflation will mean that it left no marks on the process of price formation and the functioning of our economy, there are no signs that past inflation will lead to systematically higher inflation rates in the future. This means that the latest inflation figures tell us two things: one is that the reduction of inflation will happen sooner than what we thought six months ago, and the other is that the easing process will also be faster than what we thought six months ago. But we do not have the assurance that inflation will converge to our 2% target without adjustments in monetary policy. We must be attentive to how quickly this convergence process takes place to avoid creating overshooting and undershooting in the economy, which are detrimental for economic agents. Monetary or fiscal policy are designed to be stabilisation instruments.

Q. Not all Governing Council members have yet spoken out after the last decision, but there was still a fringe of Governing Council members insisting that the door to another hike was still open. Still, would you agree that the bias is now to cut? Why the reluctance on the ECB’s part to communicate this?

A: The way we read data varies from person to person, from governor to governor, from economist to economist, depending on whether we value certain results. Still, I am sure, and can guarantee you, that we are all focused on inflation converging to 2% in the medium term. This is our collective contribution to the anchoring of expectations that I was talking about a moment ago, and in this the ECB's success has been very significant. Anchoring was made easier by inflation being a temporary phenomenon, but our monetary policy and the consistency with which we applied it helped. At this stage, I think we will all also agree on the need to continuously adjust policy to not destabilise the process of price formation. I’d like to point out, as I always do when I talk about these topics, that we had a very long period in which inflation was very low and we were unable to get inflation back to 2%. That is something that we must not forget at this moment so that there is no undershooting in inflation and that later we do not have to make a big effort to make it rise.

Q: Which will count more when you eventually consider whether to cut interest rates: increasingly weak credit developments or the growing weakness of labour markets?

A: This is an interesting question because it puts side by side two factors with non-linear behaviour in the economy. I think both dimensions should be looked at carefully in the coming months. We have seen a very non-linear behaviour of credit with negative figures in recent months, which in fact led the ECB to carry out a major review of its assessment of the tightening that has already occurred via the credit channel. And in the labour market there are also non-linearities. Fortunately, in the labour market we have a more benign situation, but non-linearities can happen and if they do, and if the weakness of the labour market is transmitted to the economy, it will certainly reach prices, it will certainly reach salaries and employment, and these are the kind of result that we would like to avoid. The latest euro area PMI data were not good. We have widespread weaknesses in the economy that are being transmitted to the labour market; in fact, many of the research notes on the PMIs referred to this continued weakness in the labour market. We must pay close attention to this. Therefore, I think that both these two dimensions being subject to non-linearities, they will be on the table from now on in all our meetings.

Q. To the extent the ECB disagrees with financial markets’ rate cut expectations, does the ECB see the issue as a misunderstanding by markets of the ECB’s reaction function, or as exaggerated expectations by markets of how much the economy is going to weaken?

A: Different readings exist due to differences in the assessment of the risk of excess tightening at a given moment in time. Anyway, I'm not going to comment on market expectations. We use market expectations in each forecasting exercise, forward market interest rate expectations are incorporated, unfiltered, into the forecast. It was very interesting to see that economic sentiment indicators in Germany were already showing an improvement in November because of an underlying expectation of more aggressive interest rate easing. And therefore, these issues will be very linked to each other. In this interface between the market and the ECB's own expectations, we must guarantee that the trajectory of interest rate reduction and the market's medium-term expectation does not bounce back to prices, derailing the process of disinflation. It is important that these two perspectives converge soon. I think that over time, we will see them converging and it has to do with this idea of ensuring that a reduction in financial tightness does not harm disinflation and expectations remain firmly anchored.

Q. Since you mentioned data released by the German Bundesbank, I would like to bring up the ECB’s Consumer Expectations Survey. In October, the survey showed that consumers' median expectations for inflation over the next 12 months were at 4%. True, median expectations three years ahead were 2.5%, but still, the data seem to be telling a different story than spot inflation data. Given the need to anchor inflation expectations, is the delay in consumers' recognition of the substantial disinflation we've experienced a matter of concern, or normal?

A: We would all like to be more prescient about the future. Consumers tend to be more resistant to incorporating inflation developments into their expectations, this is not novel. And the truth is that since a year ago, numbers showed a strong reduction in inflation (-6.3% in the euro area), so I believe the next surveys will reflect what has been happening. But if we look at a long series, the truth is that consumers are slower to adjust their inflation expectations than companies, for example. I'm not too worried about these differences.

Q. In the last Governing Council meeting it was decided that reinvestments in the Pandemic Emergency Purchase Programme would be reduced from the middle of 2024 and that they would then be discontinued at the end of the year. What do you make of this decision? And what do you think are the pros and cons of selling securities acquired under the APP instead of ending PEPP reinvestments?

A: The decision was both taken and received quite smoothly. We assessed that there would be no consequences on the markets of an announcement of a partial reduction in reinvestments starting in June next year. It does not interfere with the important decisions that we have to continue taking in terms of interest rates, but it allows the normalisation of the balance sheet – just like we did for the normalisation of interest rates. We had decided in December 2021 that reinvestments would remain at 100% until at least the end of 2024. The data we collected from the market, the market sentiment itself and the need to reduce the balance sheet all concur with the need for the ECB not to lose sight of this objective, which is to adapt the size of the balance sheet to the liquidity and financial situation of the euro area. Note that the ECB has a smaller balance sheet in percentage of GDP than other major central banks and it reduced its balance sheet very significantly with the phasing-out of the TLTROs.

Q: Fragmentation in the euro area has been limited for more than a year. How much of this though is due to the mere fact that the PEPP could be deployed to counter fragmentation if it occurred?

A: I think that the absence of fragmentation risks in the euro area now is due to a long list of factors, I will just briefly mention a few. On the one hand, there is the reduction in risk in both sovereigns and banking markets, which we observed in the euro area before the pandemic. Then, the response that was given during the pandemic, for two reasons. First, the solidarity programmes between countries and then the existence, for the first time in the euro area, of debt issued by the European Commission in euros and guaranteed by all countries. Additionally, all the regulatory changes that were made in the euro area, also in supervision, made it a more solid space from a financial point of view. Finally, the creation of the Transmission Protection Instrument, in June 2022, just before the first increase in interest rates, was a very important step to strengthen the entire process of financing in the euro area. This is a small summary of the most important facts that I think are behind the lack of fragmentation. Of course, PEPP is a very important instrument. PEPP is in fact an instrument to combat fragmentation. A massive injection of liquidity also happened in other jurisdictions such as the United States, the United Kingdom and China. In the euro area it had this very important role of also combatting fragmentation. We have been strengthening anti-fragmentation mechanisms over time. The PEPP will be with us for many years because the investments are very long-term in some cases, as long-term as the debt issuance by the European Commission, for example. Solving the pandemic problem from an economic and financial point of view will take us a long time. In fact, today we have estimates of the potential output of the euro area that are lower than those we had before the pandemic, which means that the pandemic left some marks on us. Therefore, we must be patient, we must do this calmly. I believe that the PEPP reinvestments until the end of 2024 will play this role, and from then on, the gradual reduction of the balance sheet until the moment we think we’ve reached the optimal size will do the rest.