Exclusive: Transcript: Interview with ECB Governing Council Member Mário Centeno on 3 July 2024

9 July 2024

By Isabel Teles – SINTRA, Portugal (Econostream) – Following is the full transcript of the interview conducted by Econostream on 3 July 2024 with Mário Centeno, Governor of Banco de Portugal and member of the Governing Council of the European Central Bank.

Q: Governor, first a question about the Governing Council’s retreat in May, at which there was a first discussion of the upcoming strategic review. It seems most of your colleagues would prefer to change very little about the strategy. Do you see a need to change anything? It’s only been a short while since the 2021 review.

A: This discussion started at the retreat, indeed. It is all still very open and there is no precise decision at this point, so it is premature for us to draw any conclusions about results. This interim review should be seen exactly as an interim review, and it is true that the last time we looked at these issues was in 2021, after 18 years without doing so. Therefore, I agree that everything is too recent to expect major changes.

Q: Some say the operational framework review and the strategic review should be merged, because monetary policy is not independent of the framework. Would you see merit in this idea?

A: Each thing in its own time. It is a discussion that we will have without any prejudice or preconceptions. I wouldn't like to get into it at this point because we haven't really opened it. It's not yet the moment.

Q: On another subject, how worried are you about France?

A: The euro area is a group of 20 mature democracies, and it is in this context that we must see what is happening in each country, so there are not many comments to make about the French situation. These are normal electoral processes; France is as much important to Europe as Europe is to France.

Q: You’re probably not going to be able to activate the TPI, or do you think there is a chance?

A: The TPI is a backstop that was created in 2022 and is another instrument in the toolbox we have to protect Europe from fragmentation. This is how it should be considered, as another instrument. There is no relationship between the TPI and any specific case.

Q: If you don’t activate the TPI, could that imply more aggression on rate cuts? What is the possible relation between the French turmoil and interest rates?

A: This is not a topic that needs to be on the table at the moment. The first line of defence is fiscal policy. The Stability and Growth Pact has a relevant policy coordination dimension in the euro area, and it was reviewed recently -- all countries agreed to this review. Therefore, I think we need to take a global view of these issues. And it is not a topic that arises right now, I insist.

Q: Since the June decision, you’ve stressed more often the need for prudence. Based on the flash estimate for June inflation that was in line with expectations, I assume you remain confident. What is the role of prudence now?

A: The latest numbers increased our confidence. Since March, inflation has been very close to the forecasts of the ECB and the Eurosystem. We must remember that, from September-December to March, there was a downward revision of the inflation profile, so inflation is now lower throughout the forecast horizon than we expected before. This downward revision increased our confidence about the policy decisions we must make in the coming months. My reference to prudence has two meanings. One closely linked to the statement from the last meeting, which means gradual and making sure we do not go back and forth with our decisions. Prudence has another interpretation, which is to draw people's attention to the fact that during this initial period of lowering interest rates, the financing conditions remain tight. We must all be attentive to the economic developments resulting from this fall in interest rates. In other words, we must maintain the same caution regarding consumption when faced with expenses that force us into debt. We should not think that we have reached the end of this monetary policy cycle, because we have not. In June we started another stage of this process, but prudence must remain, as the euro area has demonstrated since the beginning of the pandemic crisis: budgetary prudence, prudence in consumption, a positive behaviour of the labour market, with prudence in salary increases, as in the profit margin cycle, that now should accommodate some wage recovery.

Q: I had been under the impression that prudence was related to approaching rate cuts with caution and not rushing into it, but you are urging prudence in other contexts.

A: In the monetary policy statement, it is associated with prudency and gradualism in cutting rates. What I wanted to add when I insisted on the word prudence was to return to a logic that I had already drawn attention to previously, which is that economic agents should adapt their behaviour gradually. The association of the word prudence with the word gradual can be applied to both sides of this equation. In other words, real interest rates today are higher than one year ago, even after the first cut. At that moment, they were negative because inflation rose much faster than interest rates. Now, they are particularly high. Therefore, the fact that we have positive real rates must call for prudence in the behaviour of the economic agents. In other words, it is not because the process of lowering rates has begun that we should remove this double dimension from the word prudence.

Q: You said here in Sintra that you expect ‘a few more cuts’ this year. What does ‘a few’ actually mean?

A: The most important thing to transmit to the economic agents -- not just the markets, but also those who depend on the decisions of the ECB, such as families, companies and governments -- is that in the near future, and in line with what we have anticipated, the interest rate cycle will continue on this downward trend. In fact, the most likely next move will be to cut rates again, and that was the meaning I wanted to give to that sentence. The most important thing at this moment is to keep the trajectory in mind so that everyone knows the direction of travel. The data is coming our way: inflation is falling, and the economy in the first half of the year had more positive results than we expected - nothing extraordinary in the sense of high growth, but it is above what we expected. It is worth noting that the latest data from May shows some uncertainty about future growth. Nevertheless, the numbers are in line with what was forecasted in March. So, it is advisable to be neither too exuberant nor too pessimistic in evaluating the scenarios we have today. The baseline scenario is solid. It has risks like all scenarios, but it has demonstrated that our models capture the important trajectories of the variables of interest, namely employment, wages, inflation and activity. And that's what we should focus on. Hence, looking forward, we will have ‘a few more cuts’ this year if the baseline scenario is confirmed.

Q: Some of your colleagues have indicated agreement with market expectations of two more cuts this year, leaving interest rates at 3.25%. Of course, the ECB is not pre-committed to a rate path, but do you agree that two more cuts by year’s end is the most reasonable expectation?

A: We have four more meetings this year, so the maximum number of rate cuts is limited to four. The size of the cut is to be discussed, and therefore we have plenty of decisions to make. More important than this arithmetic, especially when dealing with few events, is to be aware of the degree of confidence that the Eurosystem has today in the trajectory we are following, which points clearly to falling rates. All economic agents must prepare, in the medium term, not in the short term, to adapt to a lower level of interest rates, without forgetting that tight financial conditions still persist, that real interest rates are positive, and that caution is advisable.

Q: In April, you said that if the March projections materialised, or if disinflation was even faster than projected, there could be room for more than 100bp of easing this year. What is your current assessment considering that the projections for annual average headline HICP inflation for 2024 and 2025 were revised up in June compared to March?

A: Overall, the June forecast essentially confirmed the one from March. My April comments had to do with a scenario in which inflation could fall more than what was predicted. Let me go back to what I see as the most important message: we have entered a new stage of the monetary policy cycle aiming at taking the interest rate to a level that is compatible with the stabilisation of inflation at 2%.

Q: Turning to the PMI and PPI data just published, what do you make of these?

A: Regarding the PMI, which was less positive than expected, we should not overreact to it, nor should we overreact to the good news from the first quarter. I think that, as a whole, they show an economy that maintains a relatively weak level of growth but remains in a soft-landing perspective. But it is a soft landing to a plateau in terms of the level of activity. That is, we are not seeing a soft landing for growth; growth is below potential. The mechanisms that will lead to the economy developing and growing in the future depend on the success of the set of policies, also monetary policy. If monetary policy manages to bring, as appears likely, inflation to 2%, we can be confident enough that, afterwards, the economy will recover. Gradually, but it will recover. On the price side, recent PPI data show that producer prices have been falling in the euro area since the end of 2022. This is a concern because falling prices are precisely the opposite of inflation. Therefore, there is an underlying element in the price formation mechanism that we should worry about because the objective of monetary policy is not to bring inflation below 2% and even less to territories close to zero, as we unfortunately experienced for nine years before the inflationary crisis we had in 2021-22. Therefore, these data should also make us think about the adequacy of the current pace of the easing trajectory.

Q: Could this discussion about the PMI be an argument to consider more strongly an interest rate cut in July?

A: The July meeting, for me, is the same as all the other meetings. We will come together to discuss, debate, and exchange opinions on how we see the euro area economy, the latest information, and the perspective into the future. Just like in all other meetings. At this meeting, we must, in fact, look at all the data, including wage data, which once again have been notably confirming our expectations. Recent wage agreements include low wage change rates for next year and the year after. The euro area has been an example of stability and caution with wage updates over recent years. We cannot waste this opportunity. The economic activity growth forecast is supported by consumption growth, and that can only happen if real wages rise. And so, we just must get a good picture of how gradually real wages have to rise. Once again, the message for everyone involved in wage negotiations is that it is not advisable to expect a concentration in gains only in the short term. Hence, it is important that monetary policy is clear about the trajectory of interest rates so that economic agents understand that they have time to materialise a recovery of real wages over the next few years.

Q: In June, the expected date for inflation to reach the 2% target was moved from the third to the fourth quarter of 2025. What happens if in September it’s moved even further, and we’re projected to reach 2% only in 2026?

A: Since the first time we projected 2025 inflation, which was in December 2022, we’ve been projecting 2025 inflation around 2%, 2.2%, 2.1%, 2%. And we revised significantly downwards the expected level of prices, as the trajectory of inflation is now lower. There is no material difference between the March and June numbers. The soft landing and inflation close to 2% work from an economic point of view. In my view, with low growth, it is better to have inflation at 2.1% or 2.2% than at 1.8% or 1.7%. A tenth of a point does not change the scenario or our determination to bring inflation to 2%, neither the fact that it is anchored in the medium term. This is clear, and we will do whatever needs to be done, in a context of financial stability, to achieve price stability. But the fact that we are discussing a tenth of a point in a year and a half seems a bit esoteric to me.

Q: Even if it is to prevent inflation from staying at 1.7%, 1.8%, as you mentioned?

A: We have no reason to undershoot inflation, and 1.7% or 1.8% would be undershooting. Inflation is converging to 2% from above; undershooting will imply that, at some point, inflation crosses the 2% target. We want to be close to 2%, but with an economy that isn't growing, a little above 2% wouldn't hurt either. The target is 2%, and we must convey a sufficient degree of confidence so that we are not disturbed by a 0.1 percentage point deviation six quarters away.

Q: ECB President Christine Lagarde and Chief Economist Philip Lane have both said that labour market strength implies no rush to decide on further rate cuts. Since you always put a lot of weight on the labour market, how do you see this argument?

A: Without commenting on either President Lagarde's or Philip’s remarks, we have to show confidence in the positive role the labour market played throughout the disinflation period. The baseline is solid and we have confidence in the baseline. But we also must be aware that the labour market has some unique characteristics, making adjustments particularly painful. In Europe, today we enjoy the highest level of employment and the highest participation rates and real wages have shown great flexibility, dropping since the beginning of the inflation cycle. Also, of the 10 million jobs created since COVID, 5 million are occupied via internal and external migrants and by workers that have low attachment to the labour market. This leads me to advise some caution regarding future labour market developments. We must be cautious because, in the labour market, adjustments tend to occur at different speeds depending on whether we are in a recovery or slowdown context. Companies are cautious about increases in hiring, but when companies are faced with the need to reoptimise their workforce, adjustments are more synchronised. This points to a careful evaluation of the trade-off between financial tightening and labour market conditions.

Q: But do you see any risk of a shift in companies’ attitude?

A: Again, referring to the baseline scenario, no, because the baseline scenario is solid. We can discuss risks, and they exist. We are already seeing some signs of a slowdown in the hiring process in the euro area. That's where slowdowns in the job market begin, it's not when companies start laying off people. Therefore, slow hiring is a leading indicator, and it is happening, in fact, in other economies, not just in the euro area. If this situation continues without any reaction in economic growth that could alleviate it, then we are moving in a direction not in line with the baseline scenario. It's not what I predict, but we have to be aware of this possibility.

Q: The discussions here in Sintra focused on the need to gather more data to deal with some open questions, especially related to services inflation. Do you agree with that diagnosis?

A: For an economic policy maker, caution is always two-sided. We would always like to decide with more certainty, to get more data and more information and so on. Because one month follows another month, then the quarter ends, then comes another projection. This has two sides, and if we want to wait until a day when uncertainty no longer exists, it is certain that it will be already too late. It is this sense of risk - that is always present in decision-making - that must also be shared with economic agents: companies, families, government, and markets. Sometimes we must, in a humble way, share the doubts we have. Because when we must act, a decision is never unanimously understood; some think it was too late, others think it was too early, some think it was too much, others think it was too little. If we can share those concerns, we actually save time because we make others understand the meaning of our decisions and to react accordingly.