Exclusive: Transcript of Interview with ECB Governing Council member Wunsch on 20 April 2024

29 April 2024

By David Barwick – WASHINGTON (Econostream) - Following is the full transcript of the interview conducted by Econostream on 20 April with Pierre Wunsch, Governor of the National Bank of Belgium and member of the Governing Council of the European Central Bank:

Q: Governor, having waited so long, until June, wouldn't it be okay to do a somewhat bigger first cut than 25bp?

A: We still have to be cautious. If core and headline were both at 2.4%, I think we would have cut already. But it’s more complicated, with services inflation at 4% and sticky, and with wage developments also still relatively sticky. So, there is stickiness on the domestic front. The models and the forecast have been performing much better over the last six to nine months than before. That to me was always the reference – we have a path to 2%, and what is our position compared to that path? We are a bit below the path that was forecast three to six months ago, and that gives some level of comfort. But then you have to consider what we have in the path to 2%: a combination of profit margins going down, productivity going up, and wage developments going to 3%. It's a possible, maybe even a likely path. At the same time, some of the components are still not where they need to be. And that argues for caution.

Also, we expect to more or less catch up in terms of real wages by the end of 2025, at which point people would say, ‘Okay, I’m back at the level of 2019, and can moderate my wage demands.’ But we have tight labour markets with a pick-up in growth that may make them even tighter, and so it's very possible that people will instead say, ‘I’ve had no real wage increase in six years. That's a long time, and I want another two years of 4%.’ And we won’t know this for a long time because the part of this which is just catching up should be a given if the economy is picking up, but the part of this which goes beyond catching up isn’t until 2026, and we won’t know much about wage levels in 2026 so soon.

That’s why I thought there was value in waiting to at least get some more detail on wage developments in 2024 and 2025, but not to get full comfort, because then you would have had to wait another year and a half or so. So, the way I look at it is okay, inflation is 2.4%. In our projection, we have a lot of base effects, so we believe it's going to stabilize for a while around 2.5% and then go down. So, we probably still want to remain a little restrictive, but we can ease to 3.5% if we have no bad surprises. Then of course there’s the question of timing and pace. You don't want to do it in one meeting. But even cutting again in July would be interpreted by markets to mean that we’re going to cut every meeting. And that would lead to repricing that might go too far. So, for me, July is not a done deal, as much as I believe that, unless we are faced with bad news, we are going to do at least two cuts in 2024. That doesn't mean for me that we're going to cut in July; far from it, we need to be cautious.

Q: When you express scepticism about the wisdom of cutting again in July, it's just because it would lead to overdone market expectations, not because there are no updated forecasts in July. Right?

A: Right. The decision in July should be about managing expectations. When you still have uncertainty on a number of fronts, you want to be cautious. And if we cut repeatedly, it will inevitably be interpreted as more cuts to come. I’m not excluding a cut in July. I’m very comfortable with cutting in June, and I think it's a done deal unless we get really bad news. My base case is at least two cuts in 2024. But if we only do two or even three cuts, then we shouldn’t communicate that we're going to cut at every meeting. And that's where it becomes a bit more difficult.

Q: Couldn’t the ECB deal with this via its communication?

A: We've seen markets getting carried away in the past based on not so much news. There have been huge swings on various occasions even recently. So, we need to keep calm and collected and not contribute to very significant swings in the market. And that's not always easy. But we should not change the basic story, which is essentially that inflation is going down at a pace that is even a bit faster than projected, while growth is probably going to pick up. So, we are in a quite good situation in Europe. I would say the worst is behind us after a year and a half stagnation. And of course, that's part of the reason why you want to cut now. You don't want the economy to get into a self-fulfilling stagnation that at some point you can't get out of.

Q: You also said that we wouldn't know for a long time with respect to wages. It seems like the goalposts are being moved, because we've been led to believe since Philip Lane started talking about this last year that we would only need to wait until the middle of 2024 to find out whether wages were going to behave themselves sufficiently.

A: Of course, we could get very good news and see that wage developments being signed now for 2025 are around 3%. That would give us more comfort. But I would not exclude that the outcomes we see as still being part of catching up remain relatively high. That doesn't mean that we should not cut rates, but it means that we still have to be cautious.

Q: So potentially, depending on the state of wage developments in two months, the ECB could do more than the base case.

A: I don't think we're going to do more than 25bp in June. I’d be very surprised. And again, July for me is very open and data-dependent, but when we say data-dependent, it's very important to understand that it's not just the inflation readings between meetings. We know for instance that momentum is going to go up again. So, it's very possible that we’ll cut rates when headline inflation is going back up. But that’s in the forecast. Because even momentum is subject to base effects, and we had very low inflation in December that's eventually going to drop out of the measure. The way I look at it is much more in variation or delta to the baseline. But it's also checking on these other variables like profit margins, productivity gains and wages to see if we have confirmation that it's moving in the direction of 2%. That's the ‘endogenous story’, from a domestic European perspective. In addition, you also have geopolitical risks and the US. Both are upside risks on the inflation front. US growth is an upside risk, because the economy is very dynamic. And on geopolitical risks, I don’t think we could look through an energy price shock, because core inflation is at 3% and wage developments are at 4%. It doesn’t necessarily mean you need to hike, but it would probably delay rate cuts.

Q: You've effectively poured water on the idea of 100bp of easing by the end of the year. It seems unlikely to be consistent with what you've said.

A: If the data warrant 100bp of cuts, we’ll do 100bp of cuts. I'm just saying I would be cautious. Based on what we know today, I would not have enough comfort to have any strong feeling about it.

Q: So, if it's warranted, okay, but based on what we know today, you wouldn't expect it.

A: I don’t think we have sufficient data today to have any confidence that we can cut by 100bp. What we know today would probably warrant at least 50bp. Inflation is at 2.5%. Easing to 3.5% would give us real rates of 1%, which is still restrictive territory. I would qualify that as relatively cautious. Beyond that, it becomes more difficult, so you really want data confirming that inflation is going to continue to go down.

Q: What can one say about where the ECB wants to wind up?

A: That’s the r* discussion and estimates of r* are all over the place. And when you see how fast the mood has changed in the US, that's also a reason for caution. It's not only markets that have been moving all over the place; the real economy in the US has changed so much in three months’ time. I would not exclude a strong pick-up in growth in Europe. We've been stagnating for a year and a half, but if you have strong growth in the US, if you have a pick-up in China and if the geopolitical risks don't materialise, I would not exclude a strong pick-up at some point in Europe. And then you don't know.

Q: At what point should the internal discussion start about where to end?

A: I don’t think we are going to have a discussion on this and then communicate where it's going to end. I think at some point we're going to see inflation and interest rates stabilise at some level - or not depending on how inflation behaves. We always tend to imagine inflation stabilising gently at 2.0%, and then we have an equilibrium rate that doesn’t move. But reality is not like that. The reality is that over the last 10 years, we've been at 2.0% for one month. We were stuck at 1% for a very long time, and then we moved from that to 10%. Because we look at models and models feature gentle landings at some equilibrium, we tend to frame the discussion as if reality were like that, but most of the time it isn't. So, this idea that the terminal rate is going to be relatively stable and compatible with 2% inflation will probably have to cede to the reality that it’s more likely to be a moving target.

Q: So, in the end, the terminal rate will only become recognisable as such in retrospect.

A: Yes.

Q: Do you have an idea as to where the dividing line is between restrictive and non-restrictive monetary policy?

A: Not a precise one. The concept of r* is interesting, but measures of r* are volatile. It's probably slightly positive in real terms, so above 2% nominally if inflation is 2%. But where exactly is another question.

Q: This suggests that monetary policy could stay restrictive for quite a while.

A: Well, core is at 3%, so I think we still need to be restrictive for some time, yes. But we should not add restriction. I mean, if inflation is going down, and you keep your rates at 4%, then you become more restrictive, because real rates go up. And that's where the first cuts will be easy, because we’re just following the path of inflation going down. After that, we'll see.

Q: What could potentially get in the way of cutting in June?

A: Bad news. I mean, really bad news.

Q: And which bad news would be most likely?

A: Two very bad readings on the inflation front or on other major developments. Or the materialisation of some geopolitical risk that leads to oil prices going up substantially.

Q: You've probably already spoken to some American colleagues here. Do you draw any lessons from their recent experience with inflation, and does it make you more cautious?

A: It certainly pleads for caution. Inflation was going down in the US at the end of 2022. Not only the Fed, but markets as well thought that there would be a slowdown in the economy and a soft landing. And then suddenly, the economy is picking up strongly, inflation readings are not going in the right direction and the mood is changing. And the mood has changed over the last year so many times in so many directions. It's still a relatively uncertain, volatile environment.

Q: Apropos, do you think that the last mile discussion is still relevant in Europe?

A: Some people say there is no last mile and progress is quite linear. When I look at the stickiness of services inflation in Europe and what's taking place in the US, it does seem that it's not going to be completely symmetric. The first part of the drop in inflation was quite symmetric to the increase. That was related to the untangling of the energy crisis and the bottlenecks. But now, it indeed seems that the way we are - hopefully - converging to 2% is not completely symmetric and that there is some resistance. Is it a lot of resistance? I'm not sure it's a very useful discussion at the end of the day, because if you say you are data-dependent, it means that you're just going to look at developments. So, if there is a problem with the last mile, it means we're not going to cut as much, and if there is no problem, then we're going to cut more.

Q: What would you say about bumpiness? One of your colleagues essentially dismisses the notion that this is of any importance.

A: It depends on how you look at bumpiness. If it means that the world is changing fast, not as smoothly and gradually as in the models, then yes, we're in a bumpy world. Do we have to overreact? No. We've done a good job at looking through some market developments. We've been calm and collected in the way we looked at things. And we've been, I hope, contributing to stability instead of adding to volatility, which, at the end of the day, is what you expect from a central bank. You cannot eliminate volatility from the world or the economy, but you can at least not increase it and instead stay the course. And I think we've been doing that.

Q: The current projections show inflation at 2% in 2025 and 1.9% in 2026. If in June either or both forecasts were to be revised down, would you not have to conclude that the ECB is behind the curve?

A: The quality of our t+2 forecast has gotten better, but it’s still not very reliable. So, for me, anything between 1.8% and 2.2% is just close to 2%. We were at 5% inflation in December 2021. We did another year of QE, because our projection was 1.8%. Of course, we had the very bad surprise of the war in Ukraine at the beginning of 2022, but I don’t buy this idea that our monetary policy today should depend on whether we are at 2.1% or 2.2% or 1.9% or 1.8% two years from now in the model. The quality of our modelling does not justify that. When we have a path to go back to close to 2% over the medium term, it gives a sort of anchoring to our monetary policy. If we deviate in one direction or another from that path, we should react. But whether the anchoring of that path is 2.2% or 1.8% in the model depends so much on the structure of the model itself and the stationarity of the model that I would not give it a lot of weight. And if anything, I think if we updated the models now with what's taking place in the US and oil prices, the revision might be slightly on the upside. And I wouldn't make too much of that.

Q: Speaking of oil prices, there is some speculation that Russian dictator Putin will do something before the US elections to boost oil prices, hurting Biden and improving the chances of his stooge, Trump.

A: I take some comfort from the fact that you have spare capacity in OPEC countries. And the question is whether some of the other big producers would want to play the game or not. Because if we had another oil shock, that would probably derail growth, and after that you might have an increase in overcapacity. You could have a big drop in oil prices, like we've seen in the past. But if there were no spare capacity in the world and Putin were in a position to hike oil prices with small cuts in Russia, the risk would be much higher. But Saudi Arabia and others have a lot of spare capacity.

Q: If in September, the Fed still has not cut rates, would you agree that the ECB is unlikely to cut a second time after having cut in June?

A: Directionally, the fact that the US economy is stronger and the fact it would not cut will increase inflation in Europe. US rates have some traction on the long end of the curve, adding restriction in Europe. But net-net, the impact of the exchange rate and of some correlation in goods prices, plus the fact that the US economy is strong, will increase inflation in Europe. But if we see developments that are aligned with our base case and forecast, I would not exclude that we cut more even if the US doesn't. I don't have a religion regarding this. We’ll look at the implications of where the economy is in the US for inflation in Europe. If it derails the path to 2%, then of course, we're not going to cut, but if we are still comfortable that we are going to 2% despite what's taking place in the US, I don't see why we should not cut.

Q: Isn’t it uncomfortable for a central bank to be in an isolated position in comparison with its peers?

A: The federal funds rate is above 5%; we are at 4%. So, there is already a spread between US rates and European rates. And the European economy has been stagnating for a year and a half, while the US economy is doing quite well. So, if, thanks to that, inflation is going back to 2% faster in Europe, allowing us to cut faster, then we will cut faster. Having said that, some people say that we don't even know the sign of the impact of what's taking place in the US. But I think if we want to be reasonable, then higher growth in the US and higher interest rates - not hikes, but just a delay in the cuts - is impacting us, and directionally it’s impacting us in a way that could indeed reduce the number of cuts or the pace at which we cut. But I don't have a rule that we can only allow ourselves one cut and not a second one just because the Fed is not cutting.

Q: There’s increasing speculation that the euro might reach or at least approach parity with the dollar. How do you see that?

A: We would try to estimate the impact of that, and on the basis of that, update our forecast. It might give more weight to the forecast in the discussion, because if you have big changes in the exchange rate, you need models. This might plead for waiting until a meeting where we have a new projection that has incorporated potential exchange rate movements. But beyond that, it's just one of the many things that are happening in the economy. We know directionally that the impact is leading to higher inflation. However, the pass-through is relatively low. I mean, euro-dollar was once at 1.6. So, we already had substantial devaluation in Europe. And it did not lead to huge spikes in inflation.

Q: We talked a bit earlier about wages. Back to that subject, do you see much chance currently of workers gaining bargaining power?

A: It's one of the big unknowns. We have tight labour markets. If you look at demographic developments in Europe, they’re going to be ever tighter. And then at some point, it should have an impact on bargaining power. And we see wage compression in the US and England and Canada. So, it looks like low-wage, low-skilled people have more bargaining power; wages are going up. In Europe, you see it less, because it’s more regulated and wage compression was already higher. But that's a big question to me: are we seeing now a sort of structural shift in the bargaining power of workers that could lead to the wage share going up? The wage share has been going down for the last 20 years. If you have a structural shift and it goes in the other direction, that could add to inflation developments and pressure in the coming years. And that's goes back to my storyline. In the model today, in our projection, we have strong wage developments until we converge to the real level of 2019. And then workers understand that they should not ask for more than productivity gains. And wage developments fall to ‘2% plus productivity’. But I don't know. If they are in a strong position, we have a pick-up in growth and there are a lot of vacancies, they could say, ‘Hey, 4% per year is great. I can demand that.’ And so, you have another one or two years of wage developments at that pace. And honestly, when you look at Europe, you see big differences between countries. The southern countries have seen wage moderation. Now you see very strong wage developments in Germany, Holland and countries like that where the labour market is tighter, which is good in terms of the internal workings of the economy in Europe, because it means that southern countries gain competitiveness and that you have some rebalancing of the economies. But it is also an indication that in very tight labour markets, workers gain market power. But again, so far, because it's essentially correcting the real wage losses of the past, it's difficult to interpret. Is it only that, or is it more than that?

Q: And is there much danger that even if wage growth does moderate as hoped, this will be counteracted by weak productivity?

A: We tend to assume 1% growth in productivity as the sort of normal rate. I think there is a risk on the downside. We've been at negative numbers over the last few years. That's probably labour hoarding, because of which we believe that, when we have a pick-up in growth, companies won't have to hire so many people and productivity will go up. But with climate change, we are losing competitiveness in a number of areas, and I would not exclude that it translates into lower productivity.

Q: How concerned do we have to be about fiscal policy, especially in light of developments in France?

A: Over the short term not so much; over the medium term I'm concerned. It's an accident waiting to happen. And especially because the political situation in many countries becomes even more difficult with the need to form governments. And when you have difficult government formation, with many different parties around the table, it typically leads to more expansionary fiscal policy. And it's just not sustainable. When it's not sustainable, at some point we will hit a wall if a correction does not take place. Probably not over the short term, because if we cut rates and the economy's picking up, that's not going to increase the risk on the fiscal front in the short run. But the next time we have a shock and debts and deficits are already too high, it can be a problem. As I said in my ECB Watchers speech more than a year ago, we are flirting with a weak form of fiscal dominance in Europe. That's not going away.

Q:  So there's no need for it to influence monetary policy in the near term directly, but what about the potential for political pressure?

A: I had a fireside chat earlier this year at which the moderator observed that there was a significant correlation between the level of deficits in countries and the hawkishness or dovishness of the central bank governor. I thought it was an interesting observation.

Q: There shouldn’t be such a correlation.

A: There shouldn't be a correlation.

Q: Isabel Schnabel the other day expressed support for a dot plot in the manner of the Fed. Can you see arguments for doing a dot plot in Europe?

A: We'd have to reopen more broadly the discussion on how we communicate, which we had during the strategic review. Going back to these issues from time to time is not a bad thing. I really believe that we've done a good job over the last year and a half. I think markets have understood where we're going. We've been contributing to less volatility, reducing volatility instead of raising it. But it's true that when we started hiking, we surprised markets two or three times in a row, and that's a trade-off you can face when you strive for consensus. And I can honestly say that Christine Lagarde has really improved the atmosphere and the mood around the table, she's paid a lot of attention and devoted a lot of energy to creating a group with a high degree of cohesion. And that helps. But if you put too much focus on consensus, you remove information from the market. And before we started winding down QE and then hiking, I could see the mood changing in the Governing Council, and I could see at some point that we had a more hawkish majority. But the markets did not see this because of the qualification of the decision as a consensus. So, there's a fine balance. On the one hand, being loyal to the organisation and trying to hammer out a consensus, which I think is better, because if you have a consensus, then your communication of course is stronger. But at the same time, if there are nuances to our views, if we disagree, I think it's good that it's out in the open. Do we need a dot plot for that? I am not sure. There is always a concern that people will try to identify who's behind the dots, and that there will be political pressure here and there when individual positions get reported. But also - and I haven't heard that argument from other people yet - the sizes of our central banks are very, very different. In the US, you have 12 regional Feds. They're more or less of equal size, while we have both very small central banks and very big ones. And I would be a bit concerned that with respect to the smaller ones that lack the modelling capacity for Europe, there would be a sort of traction towards the market forwards for lack of anything else. And then you pretend that you're not based on market forwards, but maybe a lot of governors, for lack of alternatives, would just reproduce or be close to what the market is producing. So, that would be another argument that we need to take into account, that we're not all equal in terms of the capacity to produce different versions of the world and evaluate what different rate paths would be for the European economy.

Q: Is this also an issue with regard to the macroeconomic forecast exercise, in which all the national central banks are involved twice a year?

A: But then it's weighted by the size of each national economy. And every national central bank has a model for its own economy. So, if you are, just for example, Luxembourg, you only need some understanding of the developments in your own economy. And even if you make relatively big mistakes (and I am not saying they do), it won't be visible in the aggregate European number, while every governor would have a dot on the plot without that weighting process taking place.