Transcript: Interview with ECB Governing Council member Šimkus on 18 February 2025

20 February 2025

By David Barwick – VILNIUS (Econostream) - Following is the full transcript of the interview conducted by Econostream on 18 February 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, some of your colleagues like to say that the direction is clear, others prefer not to say this. Everyone agrees that there is huge uncertainty. Is the direction clear and how can it be under extreme uncertainty?

A: There are many big risks around our target, so uncertainty is very high. But whether we’re talking about tariff threats and likely retaliatory measures, or about economic weakness in the context of the complicated and evolving geopolitical situation, these risks are two-sided with respect to inflation. This highly uncertain environment naturally leads to less willingness to make claims about the future, because nobody knows what will happen. If we abstract from all the risks and assess the data we have, then we see that the euro area economy is sluggish: we’ve already revised down our 2025 growth projection several times and will probably lower it again in March. Meanwhile, our best information points to diminishing wage pressures, and we expect headline inflation to return to 2% this year and remain somewhere near 2% next year and the year after. It is worth reiterating that this is in the context of sluggish economic activity. The natural question is, will we need a restrictive monetary policy if inflation converges to the target? Obviously not. And yet, interest rates are still in restrictive territory at the moment. Therefore, I agree that the direction of travel is clear. We are not able to be precise about the pace and the path of rate cuts, but it's clear that we are moving interest rates downwards, and I don't see any good reason not to do another rate cut in March. We’ll see about April and June. But overall, the direction of travel is clear, and for me, the next move is clear.

Q: You observed that we’re still in restrictive territory now. And after the cut in March?

A: This brings us to the discussion of where the neutral rate is. I understand that it is easier to think and communicate about it as a concrete numerical estimate; however, I tend to think about it as an area of rates, even if the area is not wide. And I consider the nominal neutral rate to be in an area around 2%, which is consistent with the research just published by the ECB. So, yes, after March we will still be in restrictive territory. However, as we approach this neutral rate area, I think we should avoid placing too much emphasis on being above or below it, given the significant uncertainties surrounding these estimates.

Q: Would you then argue for keeping ECB language that describes monetary policy as still restrictive?

A: Nobody knows exactly where neutral is, and there are models that suggest that it could be well above 2.25%. In any case, it's not the language that defines the actions, so I wouldn’t focus too much on whether the statement says monetary policy is still restrictive or not. Whether we keep this description or not does not by itself change the actions we take.

Q: But would you expect to keep it or to change it?

A: I don't have a very strong view on this particular point. With the DFR at 2.5%, we will definitely be approaching and even be rather close to the neutral interval around 2%. But we won’t be there yet, so I wouldn’t mind keeping this language. It would better reflect reality to keep it. But there are arguments going the other way, so maybe this will be the time to drop it.

Q: You said earlier: March yes, and we’ll see about April and June. Does this mean that you think that market expectations are overdone?

A: No. Generally, I agree with market expectations that there might be another three cuts between now and the end of 2025. Markets have to form expectations of when these cuts will occur, while we have the luxury of making decisions without committing to where interest rates will be in, say, October 2025. Therefore, even if I have an expectation of what will happen in March, which is quite soon, I have no problem saying that I don’t know the exact shape of the interest rate curve further in the future. But as I said, the direction of travel is clear in a context of weak economic developments and with data showing that we’ve hit our medium-term inflation target. So, I don't see any good reason for policy to stay anywhere far from the interval I described as nominal neutral, which is around 2%. Policy needs to return to this interval around 2%. In this pretty complex economic context, I think we have to stay in restrictive territory just as long as necessary. Especially since past tightening still hasn’t passed through completely.

Q: Have incoming data since December been consistent with the projections?

A: They confirm not only what we projected in December, but in fact projection errors have become a lot narrower over at least the last year. So, reality has been broadly in line with our projections ever since the beginning of last year, if not earlier. Individual components of the projection may differ from what we observe, but overall, we have been pretty good at identifying the clear disinflationary trend, a decline of wage growth and – unfortunately - weaker economic activity.

Q: You mentioned earlier that you, like many others, expect the next forecasts to include a downward revision of the growth outlook. What about inflation?

A: I wouldn’t focus too much on near-term inflation. For me, inflation at the end of 2025, in 2026 and to some extent in 2027, at least directionally, plays the most important role. Here I don’t expect much change, even if there are very considerable risks that are hard to assess. If and when these risks materialise, we will incorporate them in our projections, but as long as it’s unclear, we should take reality as it is. Of course, the uncertainty about the risks also plays a role and diminishes economic activity. But for now, I am focussed on our December projections showing us converging to our medium-term target by the end of 2025 and then remaining in that region in 2026 and 2027.

Q: How do you see the balance of risks between over- and undershooting the inflation target?

A: The risks I alluded to, especially related to tariffs, will definitely have an impact on inflation over the next couple of years. I would hesitate to conclude now whether we will undershoot or overshoot in this period. What is clear though is that the economy would suffer as a result of trade tensions, so that the probability is higher that at some point in the future we will end up with inflation below target.

Q: And how do you feel about the possible impact of the weaker euro on developments?

A: The weaker exchange rate supports exports, but we don’t have any target level. It depends on a lot of political decisions that we might see in the near future and it is impossible to forecast.

Q: How confident are you that we're finally going to see a genuine economic recovery, given your expectation of a downward revision to the growth forecast?

A: Some time ago we tended to think that we're going to see some sort of recovery in 2025, but it is clearer and clearer that growth in 2025 might instead resemble the weak growth of 2024 rather than being something that can be called a genuine recovery.

Q: Back to the outlook for interest rates, it sounds like even if markets are correct in expecting several more rate cuts this year, they may be underestimating the likelihood of a pause in April.

A: In April, even though it is not a projection meeting, we will have a better understanding of the reality we’re operating in. We’ll have more clarity about the things that make the outlook so uncertain at this moment, such as US trade policy. This will help streamline our thinking about what our next steps should be. And once again, we don’t need the restrictiveness of our current policy stance, given everything I already mentioned. So, the direction of travel is clear, even if the high uncertainty forces me to be more cautious about our decisions in April and June.