Transcript: Interview with ECB Governing Council member Šimkus on 2 September 2024

3 September 2024

By David Barwick and Marta Vilar – VILNIUS (Econostream) - Following is the full transcript of the interview conducted by Econostream on 2 September with Gediminas Šimkus, Chairman of the Board of the Bank of Lithuania and member of the Governing Council of the European Central Bank:

Q: Governor, we don't think there's any doubt about a 25bp cut in September. But some people might, out of concerns about growth, for example, already start pushing at the September Council meeting for a cut in October. Do you see much chance of a cut in October?

A: We started cutting in June, even though at one point in time the market expected us to start sooner. We are gradually, consistently and predictably delivering the appropriate policy moves for the circumstances. The question about cutting in October is to a large extent the same as the question of whether at one of the meetings left this year we would consider cutting by 50bp. I know the market is currently pricing in an October cut with a probability of about 40%. A couple of months ago, the market didn’t see any chance of an October cut. The fact that the market now attaches a fairly high probability to an October cut does not correspond to the data, in my view. The ECB was not late to act, and our monetary policy is aligned with the data. Inflation is falling quite noticeably. But is this unexpected? No. It was anticipated already some time ago that inflation developments would be bumpy this year. So, we shouldn't be surprised if we see inflation higher again in the coming months, and we should not be afraid that the sky is falling. It’s all been anticipated. And while I have not seen the newest macroeconomic projections yet, I don't believe that they will change substantially, because the data have been more or less in line with what we expected. So, we still believe that we are gradually and predictably converging to the 2% inflation target in the second half of next year. Again, we were not late to act, and we are gradually and predictably implementing the necessary steps. For the cut in September I see a quite clear case. For cutting in October or by more than 25bp, I find it quite unlikely.

Q: And is the low probability of a cut in October due to the absence of new projections then?

A: No. It has to do with the fact that inflation is already very gradually converging to 2%. Previously we were complaining a lot about forecasts errors, so the way it is now is how it should be: the inflation projections have been fluctuating in a quite narrow interval since the beginning of 2024, and in an even narrower one for 2025. Time passes, but the inflation projections remain very stable. This is reassuring. So, my thinking of low probability for a cut in October has nothing to do with not having updated inflation projections, because even without new projections, you can quite reasonably act on the basis of the data you have and whether or not those data are consistent with what was expected.

Q: You were very clear that you don't think there's any argument for 50bp, but the economy is weakening, wage growth has come way down, and as you said, disinflation as of August has been very noticeable. Don't you think at some point the ECB will have to ensure that it doesn't fall behind the curve and do a larger rate cut?

A: The short answer is no, because I don't think the ECB is falling behind the curve. Policy is necessarily predictable and gradual, because we always need to balance the risk of doing too little with the risk of doing too much. If we cut too little, we would squeeze the economy unnecessarily; if we cut too much, we might refuel inflationary pressures. So, we always need to balance these two risks. I remember that at a certain point earlier this year or last year, there was this idea flying around that it's better to do a little bit too much than too little. I could not agree with it, because I think we are paid to do as much as needed, no more and no less.

Q: So, you clearly wouldn’t consider market expectations of three rate cuts by the end of this year as reasonable.

A: We are not driven by market expectations, which can be quite volatile and react to short-term events. We've seen market expectations change a lot; just look at where they were at the beginning of this year. We need to assess the inflation outlook, the dynamics of underlying inflation and the strength of monetary policy transmission. What's clear is we have quite sluggish economic developments; if you exclude Ireland with its volatile data, growth in the second quarter was basically flat. So, the economy is sluggish, and not only in the latest quarter, but already for two years in a row. We also have a very clear disinflationary trend. Services inflation could be better, but still, we have a lot of good news on the inflation front, with headline inflation down to 2.2% and core inflation also down. All this clearly indicates that it’s appropriate to ease monetary policy. By how much and in exactly which month – time will tell. But the direction is quite clear, and as I said, there are many compelling arguments for cutting rates in September. If the question is whether to prefer October or December for the next cut after September, then I would say that for a December decision we will definitely have more of the data that we need to do the right thing – not too little and not too much.

Q: And what if the Fed overtakes the ECB and cuts surprisingly quickly?

A: For some reason, many in the markets believe that we are somehow competing with the Fed, so it’s a matter of who is the first to cut, whose cuts are bigger or more frequent. Of course, we are monitoring the Fed's actions and how the US economy is performing, because it's a very important trade partner. Economic developments in the US definitely affect the economy of the euro area. But I doubt Jay Powell gets asked whether the Fed is late to cut rates because the ECB has already cut. Having said all this, the exchange rate is one of the elements that enters into the macroeconomic projections, and the euro has strengthened versus the dollar. Right now it's more or less 1.10. But there have been plenty of occasions when the exchange rate was higher, and plenty when it was lower, even just within the last five years. We are more or less at the average, so we shouldn't make too much of recent developments. The Fed is doing its job, and we are doing our job.

Q: Going back to the projections, do you still expect the inflation target to be reached by the end of 2025? And if reaching the target were to be pushed out into 2026, would that be a reason for you not to want to cut in September?

A: First, I don't expect this scenario. One can come up with many scenarios and ask, “What if?” The main scenario is that inflation will be bumpy. So, it has fallen noticeably but could increase again in the coming months to above the level of August. We need to see inflation consistently stabilising at around 2%, and that's what I believe is going to happen in the second half of 2025.

Q: So even if the projection of when we get back to 2% inflation moves a little bit farther into the future from 4Q 2025, which is where it is now, it doesn't change the big picture.

A: It doesn't change the big picture.

Q: And are we going to see a recession?

A: Growth is sluggish and the risks are to the downside. There are issues that are not cyclical but rather structural that lead to this sluggish economic performance. But, again, as regards monetary policy, I think that we are talking about the path that is neither too tight nor too loose. 

Q: Policymakers have been increasingly willing to say where they see the nominal neutral rate. And it sounds like they think it's at 2.25% or 2.5%. Do you agree?

A: Nobody really knows where it is, so there are many different views that fluctuate around the levels you just mentioned, from 2% to 2.5%. The interval from 2% to 2.5% is quite narrow. I still think that it’s somewhere there, but what’s even more important is to stabilise inflation at 2%, wherever the neutral rate is.

Q: Should the ECB stick to its meeting-by-meeting, data-driven approach?

A: It’s very important that we take decisions meeting by meeting and data-dependently. I think it’s crucial, in particular under such high uncertainty. War is ongoing in Europe, and this already means huge uncertainty about everything. So, we need to admit that we can’t know everything in advance.

Q: Do you see any room for the process of shrinking the ECB’s balance sheet to be accelerated?

A: It will accelerate by the end of this year, because we will stop the reinvestments under the PEPP. But if you are asking whether we should start actively selling assets, I would observe that with inflation easing, additional tightening is not warranted. That is, in a matter of not so many years, we will reach a level at which we have to think about what the structural size of the balance sheet should be. Because of regulatory changes and some other factors, the structural balance seems likely to be higher than in the years before. It’s still to be decided how big it should be, and this will depend on the operational framework. But for now, I don’t see good arguments for speeding up the shrinking of the balance sheet.