Transcript: Interview with ECB Governing Council Member Mário Centeno on 17 April 2024

22 April 2024

By Isabel Teles – WASHINGTON (Econostream) – Following is the full transcript of the interview conducted by Econostream on 17 April 2024 with Mário Centeno, Governor of Banco de Portugal and member of the Governing Council of the European Central Bank.

Q: Governor, there are high expectations of a rate cut in June. After waiting so long, wouldn't it make sense to start with 50bp? Are there any chances of this happening, or are you resigned to 25bp?

A: This expectation you speak of is justified, given the ECB’s communication following our last meeting, although it is always important to note that the decision will be based on a new forecast for the euro area. The previous forecast brought surprises that included a downward revision of growth and a downward revision of the inflation trajectory, which probably made the next phase of this monetary policy cycle with a reduction in the rate clearer. So, let's see what comes with the forecasts in June. Determining a metric, a measure for the size of the monetary policy adjustment, is only possible once this information is known.

Q: Some of your colleagues think it's best to cut rates only at projection meetings, i.e. quarterly. Do you agree with this limitation? Would this imply bigger cuts? Is there a correct rhythm, a priori?

A: Of course not, this would no longer be data-dependent and, therefore, it would be a violation of what has been our strategy over all these months. The strategy has proved to be appropriate for making decisions at the proper moment, and that is what we must continue to do. There is no obligation to adjust rates at all forecasting meetings, if the data do not warrant it, nor must it ever be impossible to adjust them in the remaining meetings if developments justify it.

Q: You were one of the Governing Council members who didn't need to wait before finally cutting. What convinced you last week to support the consensus?

A: Decisions are always collegial, and collegial decisions are taken knowing the opinion of each member, but they are taken by all members jointly. From that point of view, individual wishes and preferences are no longer relevant. What I have been saying for a long time is that the data and the downward revisions we have made for inflation, but also for economic activity, force us to look at the data with additional concern. At the moment, we are very close to 2%, and in fact we even predict that in the coming months inflation, although initially only temporarily, will fall below 2%. We cannot lower rates only when inflation reaches 2%.

Q: With this, and considering that in one year, inflation is projected to be very close to the 2% target and, in 2026, it will be below it, doesn’t this suggest that the ECB is behind the curve?

A: The biggest risk I see is that the ECB's economic forecast, as well as other institutions, is supported by what I have labelled the labour market dividend. The behaviour in the labour market  has simultaneously allowed what has rarely happened in the past, which is a process of disinflation while avoiding recession. We have not had anything that could be considered stagflation, despite the European economy not growing for a year and a half, because stagflation is characterised by high unemployment, and we are far from such a situation. If we had had labour market behaviour that did not provide more jobs and wages compatible with the reduction in inflation, we would have had a set of challenges greater than those we face. Therefore, we also have to be aware, so to speak, of the good times that the job market brought to our economy. This also means, on the monetary policy side, making an effort not to jeopardise the functioning of the labour market as it is known today.

Q: And do you believe that now is the time to make this effort to avoid the risk of taking too long?

A: Exactly, because this is the big risk we run. Because if we wait too long, a deterioration of the situation in the labour market may lead us, perhaps, to talk about more aggressive rate reductions. I am in favour of setting economic policy in general, and monetary policy in particular, gradually and at the margin, anticipating difficulties rather than trying to resolve them only after they have arisen.

Q: In the March projections, the date for reaching the 2% target was brought forward. Do you think it could get even closer in the June projections?

A: We have inflation already reaching values ​​below 2% year-on-year in some months this year. We have, as of mid-2025, inflation consistently slightly below 2%. In other words, inflation is currently at 2%, there is not much doubt about that. We therefore have core inflation slightly above this, half a percentage point, and what we predict is that core inflation will remain in the range between 2.5% and 3%, compatible with headline inflation close to 2% over the next few months. And the same thing is true for services, which will also be a little above core inflation, but at values ​​close to 3%, all of them compatible with our inflation objective, because our target is not core, it is not inflation of services, it is the headline. Therefore, all these values ​​are compatible with our mandate, it is on this basis that we must consider the next steps.

Q: Even if it follows a ‘bumpy road’, as has been said lately?

A: It surprises me that this is expressed as a concern. After all, inflation is a variable that looks backwards, and as such is always likely to be subject to base effects, since any given monthly variation in inflation remains in the indicator for 12 months. Therefore, inflation fluctuating between 1.8% and 2.4% is what we want going forward because inflation is unlikely to remain fixed at one number in the years to come. This has never happened in the past, inflation is always bumpy, this is neither a statistical nor an economic issue. Now that attention is being drawn to this, I confess that it surprises me from an analytical point of view.

Q: You previously said that you would not like to comment on market expectations for four rate cuts this year. Could you comment on the possibility of a 100bp reduction by year’s end?

A:  I say that I do not see myself involved in the debate about market expectations, but our models   use market expectations to make forecasts. Inflation is an endogenous variable in the model, it is not a hypothesis, therefore, it results from the behaviour of all variables, including those that are hypotheses in the model. And one market-based hypothesis of the model in March was, precisely, that there would be rate reductions during the year 2024 that cumulatively reached 100bp. In other words, our economic forecasts are compatible with and, in fact, incorporate an underlying total reduction this year of 100bp. Since the production of this estimate, inflation was lower than expected in March, which is the last number we currently have, and economic activity was also revised downwards. What can I say? A reduction of 100bp this year, being compatible with our result and our forecasts, is compatible with inflation of 2%, which is our objective.

Q: Does this mean that the reduction this year could be even greater than 100bp?

A: Yes, potentially. It depends on the confirmation of this reality, because we will reach 2% faster than we expected to in March.

Q: As you have noted previously, disinflation is proceeding faster than inflation.

A: Indeed. It has also been faster in services. Of course, there is what in academia and mathematics we call an asymptote. Inflation is approaching 2% and obviously it is getting closer with smaller and smaller steps. And this, from a mathematical point of view, but also from an economic point of view, means converging to 2%. If we had maintained the rate of disinflation that we had during the year 2023, at this point we would already be in deflation. It was inevitable that the rate of reduction in inflation would decrease, because otherwise we would not reach the objective. And there is a moment when it will ideally stop, and this should not cause us any anxiety regarding our decisions.

Q: Precisely where does the ECB want to go? And what would be the appropriate level of flexibility for this?

A: We have a box in the ECB's March economic bulletin that analyses the topic of the neutral rate, which would be an approximation of the terminal rate of this process. There is some uncertainty about what this value is; it could be 2% in nominal terms, that is, a real neutral rate of 0%, it could be around 2%, a little lower - there are more estimates below 2% than estimates above 2%. But I would say that as a benchmark, an interest rate target at the end of this monetary policy process close to 2% is, at the moment, a good benchmark for that. Which means that even if we do one, two, three, four cuts of 25bps, we will always have an interest rate higher than the neutral rate, that is, we will still be in a region where there is financial tightness.

Q: You recently said that if the ECB has to act to cut interest rates before the Fed, it will act and there is no problem with that. But if we get to September, the time for another ECB rate cut, and the Fed has not yet been able to start cutting rates due to persistent inflation, you would agree that the ECB would hesitate before acting again, right?

A: This is a question about a very distant moment in terms of monetary policy. I know it's not long until September, but in monetary policy there are at least two more decisions before then. We have a different mandate at the ECB than the Fed, and we obviously also have different economic and inflation data. What is different today is what will determine the decoupling. That is, it has nothing to do with wanting to follow a different path than the Fed, but rather it has everything to do with the data that the ECB has to take into account to make a decision and those that the Fed has for the same purpose. In other words, today we have inflation clearly close to 2%, whereas in the USA it remains above 3%; we have an economy that is not growing, zero in a year and a half; the North American economy is growing. The only thing that is similar in the two economies is the dynamics of employment, but not in terms of wages, while wages in the USA apparently exert pressure on demand and, consequently, on prices, in Europe what we have observed is real wage losses. In other words, we have very different realities , and this is the true decoupling.

Q: So, do decisions really need to be independent?

A: There is no other alternative. We are accustomed, and rightly so, to seeing the coordination of monetary policies as being a very important factor in the cycle of rising rates, but we forget that this was the moment of greatest global coordination of monetary policies that we have ever had in our recent history. It's a good principle, but it happened because all central banks felt the need to do it. It is also true that the Bank of Japan had a much shorter monetary policy cycle than other central banks. Many banks in emerging countries raised rates much earlier than the US or the ECB and also stopped doing so earlier. That is, each central bank has to look at its economy and decide on that basis. There are certainly global consequences of the actions of the largest central banks, and no one pretends otherwise, but this is not the same as a restriction on the policy actions of independent central banks.

Q: Even though the ECB does not target a specific exchange rate, a devaluation of the euro could mathematically increase inflation. Could this delay the interest rate reduction movement?

A: We have no objective regarding the exchange rate, we know that there is a relative price and, as a relative price, it suffers precisely from the market. A situation like the one we may face would trigger a series of adjustments in the market not limited to just the issue of import prices. We believe that, as in other episodes that have also happened in the world economy, in the euro area the relative price between currencies in different countries will adjust without the ECB having to react to this variation. It does not seem to us, given the scale of what we are seeing, that this will have a material impact on inflation.