ECB Insight: Stournaras’ Comments Right on the Money

2 August 2024

By David Barwick – FRANKFURT (Econostream) – It can be tempting to dismiss the utterances of those European Central Bank Governing Council members who habitually tend to the extremes of hawkishness or dovishness. An exception is worth making for the latest contribution of Bank of Greece Governor Yannis Stournaras to the discussion.

Not that the interview with Platow Brief released Thursday lacked the hallmarks of a Stournaras intervention. By that we refer to tendencies to warn of potentially dire consequences of the wrong policy stance and to seem to consider economic growth the mandate of the ECB.

And yet, we think he is on the money this time in several respects. First and foremost is his explicit linkage of the Governing Council’s decision to the updated forecasts:

‘The ECB projections on inflation and growth in September are important’, he said. ‘If inflation continues to fall as expected, gradual rate cuts would be appropriate in order to strengthen economic momentum.’

In other words, if prospects for a return to price stability are not seen to have eroded, another 25bp cut would be the correct move. The logic doesn’t only apply to September, which is why he very appropriately refers to ‘cuts’ in the plural.

We share his view and have posited repeatedly that if the inflation projection does not worsen significantly versus June, then a September cut is likely. While no one can be precise about how significant a deterioration would need to be to hinder more easing, a small worsening would probably not be sufficient.

Should the updated projections show no change in the outlook for the return to 2% – let alone the case in which the timetable is actually shortened, perhaps due to weaker growth - then it becomes quite unlikely that the ECB would fail to cut in September.

This goes back to another idea we expressed here very recently, namely that the ECB would need a reason not to cut interest rates more than it needs a reason to cut. If next month the updated projections either downright support cutting or fail to argue against it (the ‘moving sideways’ case), then the default decision will be to reduce borrowing costs again.

Naturally, incoming data has the potential to change this or anything else. But for now, we remain quite comfortable with our advice here earlier this week to shrug off July HICP data as insufficient to derail the easing process.

We also like some of what Stournaras said with respect to growth: ‘The renewed signs of weak economic activity and the high level of uncertainty will very likely dampen inflation more than had been expected.’

Though for him the inflation-dampening effect of weak growth is an argument of convenience more than conviction, the fact remains that the Council has for many months hoped – and fed observers’ hopes – that its policy tightening would lead to a soft landing of the economy.

Barring the kind of inflation resurgence currently classed as a tail risk at best, no one wants to see the economy tank or unemployment – which most recently climbed – increase substantially. We can’t help but think that even beyond the dampening impact of feeble activity on the inflation outlook, policymakers will be particularly sensitive to the threat of the economy heading south.

We also like the part of the interview where the questioner seems to turn the tables on Stournaras and solicits his agreement with what we see as the fundamental, underlying argumentation for regular further easing in September and beyond, as long as the prospects for a return to 2% remain intact.

Here, Stournaras is first asked whether the ECB wouldn’t need to cut to 2.5% - the upper limit of the range in which Stournaras suggested the nominal neutral rate was – by end-2025, when 2% inflation should again prevail.

Stournaras agreed – how could he not? – but noted that the world was uncertain. The latter observation of course is true, but we would argue that the ECB’s projections guide policy and that uncertainty about what could actually transpire cannot justify policy decisions that fly in the face of the projections.

But Stournaras having in any case conceded that the ECB would ideally get to neutrality when inflation gets to 2%, the interviewer correctly observes that, purely mathematically, this would require a good number of rate cuts - unless of course the projections were disbelieved.

Here Stournaras reiterated that things were uncertain and invoked the bumpiness of the inflation path, though he also confirmed that the July flash estimate of euro area HICP was ‘in line with our projections’.

We think Stournaras would have been better off simply agreeing wholeheartedly that the ECB had to keep in mind the lingering chance that its policy decisions could wind up lagging developments, and repeating that this is why, unless the outlook deteriorates, regular cuts should and would be the order of the day.

We are reminded of what we said here on 16 July to explain why we were already inclined to expect a September cut, a line of reasoning we said ‘follows that expressed by some Council members in explaining to Econostream their support for the June rate cut.’

‘According to that logic, in the absence of an important reason to doubt the projections – the reliability of which policymakers have been lauding for months – then given the current unambiguously restrictive level of interest rates, a certain amount of easing has to be accomplished by end-2025’, we wrote. ‘If the ECB, inclined to small steps, doesn’t want to fall behind the curve, that indicates small rate cuts on a somewhat regular basis.’

Stournaras’ questioner gets it, and certainly Stournaras does too. The latter, it is worth remembering, had already asserted earlier in the same interview that ‘[i]f inflation continues to fall as expected, gradual rate cuts would be appropriate in order to strengthen economic momentum.’

True, Stournaras’ thinking, not uncharacteristically, was driven by considerations of economic growth. One could however remove the last six words of his sentence. The result, we find, would constitute a very reasonable conspectus of the current monetary policy outlook.