By David Barwick and Marta Vilar – VALLETTA (Econostream) - Following is the full transcript of the interview conducted by Econostream on 18 March with Alexander Demarco, Acting Governor of the Central Bank of Malta and alternate member of the Governing Council of the European Central Bank:

Q: Governor, the ECB seemed surprisingly hawkish on 6 March. Too much so? Or did markets overinterpret President Lagarde?

A: One has to recall that the meeting that was held on 5-6 March took place at a time of incoming news from both sides of the Atlantic that elevated economic uncertainty to new highs. On Wednesday we witnessed wide swings in financial, exchange rate and commodity markets reacting to such news. This high uncertainty, if anything, has undoubtedly reinforced the view around the table of the Governing Council of the need to be even more data dependent and to adhere to a meeting-by-meeting approach in the monetary policy decision-making process. It is certainly not about anyone being hawkish or dovish, or some other kind of bird, at the current juncture. When navigating through thick fog, you need to continue to move forward but analyse even more carefully each piece of information to reduce the risk of taking a wrong turn. So everybody has an open mind on the way forward. And that's why we're not precommitting to any path, because nothing is clear.

Q: What are major sources of uncertainty?

A: Announcements by the Trump administration that they then reverse, like tariff decisions for Mexico and Canada. This creates uncertainty. There is also a lot of uncertainty about the impact of tariffs on inflation. In the short term, there could be upward price pressures, especially if there is retaliation by the EU, which appears to be almost certain. But a tariff war would be a hit to demand for all economies, which can only bring about lower price pressures in the medium term, even if it raises prices in the short term. And in the case of defence spending in Europe, a lot of questions remain. When we met, it was not even certain that this would be approved by the Council. Now it has been, but we don’t know exactly how the money will be spent, whether it will only be used to buy arms made in Europe, whether we will rely on imports, whether we even have the capacity to produce what is demanded, and so on. And will fiscal governance rules be respected? All this remains to be seen, but it will be very important to closely monitor developments to see whether this is going to result in a more expansionary fiscal policy or not. And although military goods are not in the basket of goods covered by HICP, there could be indirect effects, like on raw material prices, which could have implications for consumer prices.

Q: If today were 17 April and not 18 March, is there a decision you would clearly deem correct?

A: No, because I also need to see what the ECB staff does in terms of the inflation impact of recent developments. Our latest projections show us pretty much on track in achieving our objective, even if reaching 2% has perhaps been pushed out to early 2026 or late 2025. But the revisions of the previous projections were driven entirely by energy prices and the exchange rate, and since then, we've seen important changes in these components, both in the direction of lower price pressures. And maybe there will be effects from tariffs; this is unclear and I am not even sure this will be clear in April. So, for now, we are guided by the projections we have, but if energy prices and the exchange rate remain as they are today, the projections will probably show 2% achieved even earlier. So, I’m not sure it’s the right time to pause, because the evidence still shows us moving in the right direction. There is just a lot of noise around us, and we need some more data between now and April to identify emerging tendencies in one direction or the other.

Q: It's more the case that you need new information that tells you to pause in April than it is that you need new information that tells you to cut, right? Because we were cutting already, and 2.5% is not the terminal rate. So, the default is to continue cutting, correct?

A: Yes. The errors of ECB staff in recent projection exercises were pretty small with respect to inflation. So, it would seem that we are really on track in achieving our goal of 2% inflation. So if nothing changes, that is the default. But it's not the case that nothing can change. There is a lot of turbulence surrounding us, and this could have an impact on inflation, especially in the short term. One also has to see whether this impacts inflation expectations, because higher expectations could change things. On the other hand, the turbulence could also give rise to a loss of investor and consumer confidence, which would have negative effects on demand and economic growth. We had already been seeing economic growth revised downwards with every projection round. Okay, we continue to project a recovery. But economic growth is still pretty weak. And these negative events, including more trade barriers, are not likely to generate positive sentiment, to convince consumers to spend or to encourage investors to invest. And that, to my mind, would signal downside risks for medium-term inflation.

Q: In the medium term, the main risk is still undershooting, true?

A: I think so. Especially if the trade war intensifies. It's deflationary in the medium term, at least.

Q: Wouldn’t April make sense to pause, given the lack of projections and the proximity to neutral? Maybe all the uncertainty argues for proceeding more slowly after 2.5%?

A: As we say in our statement, we are data-dependent, and given the current elevated uncertainty, it has become even more relevant to remain so. Therefore, we need to evaluate the incoming information that will be available to us at that time and keep an open mind to act in a way we think is more appropriate. The lack of new projections in April per se does not tilt the balance in favour of pausing compared to a meeting that coincides with new macroeconomic projections. A fresh projection round could in theory equally support a pause if the information points in that direction.

Q: When does a discussion about a possible pause need to start? What should drive the decision to pause?

A: Our monetary policy decisions will undoubtedly remain driven by the outlook on inflation in reaching the 2% target in the medium term, that underlying inflation also moves in this direction in a sustainable manner, and the effectiveness of the transmission channel of monetary policy. In the ECB’s staff projection exercise, the outlook for inflation is conditional to a particular interest rate path, and as long as the incoming data and conditions continue to signal that we remain on track, as was the case in the latest projection exercise, then we should continue to follow that interest rate path. If not, we would need to reassess what would be the best course of action to achieve the goal of price stability.

Q: What will determine that policy is not restrictive anymore?

A: Clearly, monetary policy at this point is still a bit restrictive. If we start seeing a range of indicators showing market financing conditions becoming clearly looser, that could be a sign.

Q: Is the BLS very important for this?

A: The BLS is something we always look at, of course, but it's not the be-all and end-all. It's one indicator. Market financing conditions are also important. We also have to see yields, equity markets and so on.

Q: Although we won't have new projections in April, we'll have the mechanical updates. Will these be particularly important, because of what's happened since March?

A: The mechanical updates will be important, certainly with respect to energy and the exchange rate. If we see downward revisions to inflation and the target can be achieved even before early next year, that should give more confidence for sure about the policy decision.

Q: Without new projections, how will you take into account any previous tariff announcement by Trump?

A: The ECB staff have already put in a lot of effort into providing different scenarios of a world with increased tariffs by the US. Of course, their impact varies depending on the new tariff rates, their coverage of products, and also on whether countries, especially the EU, retaliate to such tariffs, which in recent days has become more of a reality. Nevertheless, there are still as yet unknowns, and we have already witnessed delays and partial reversals to previous announcements by the US, which is why we state that uncertainty has increased to new highs. The fluidity of the situation makes it harder to assess. Let’s wait and see how this situation evolves and reassess all the information that becomes available at that time. This is also why we emphasise our stance of being data-dependent and take a meeting-by-meeting approach, especially in such times.

Q: At the ECB Watchers conference last week, Madame Lagarde said that the ECB should ‘help reduce, rather than amplify, uncertainty.’ Would pausing in April amplify uncertainty?

A: If the incoming information suggests that it's better if we take a pause, because, let's say, inflation expectations are rising or some new inflation data are worse than what we were expecting, then it could be justified. I don't think a pause in this case should add to uncertainty. In the introductory statement, we always give the motivations of the decisions we take.

Q: How will the increase seen in Eurozone bond yields recently affect the ECB’s ability to ease further?

A: Firstly, it needs to be noted that although Eurozone bond yields increased significantly, spreads remained broadly stable. However, the increase in long-term yields undoubtedly has tightened financing conditions for sovereigns and this is also likely to tighten financing conditions to corporates too. This rise in bond yields was triggered by the need for Europe to spend more on military defence to be more autonomous in this regard. That is a choice that European governments have made. If this represents only a shift in expenditure preferences and the new fiscal governance rules are respected, then this should not represent a significant departure to the staff projections and the embedded interest rate path that would achieve the price stability objective. If on the other hand fiscal positions become looser than the announced budgetary plans, this would need to be factored and reassessed accordingly. Therefore, as usual, we will continue to monitor very closely fiscal developments and the evolution of inflation expectations.

Q: We were recently told by a former colleague of yours that German bond yields of 2.90% or above were an overwhelming reason to cut. Do you agree?

A: Looking at bond yields alone is not enough. You have to take a wider perspective.

Q: Speaking of German fiscal policy, what impact could a reform of the debt brake have for the ECB?

A: Clearly, if Germany were to adopt a much looser fiscal policy and public debt were to rise appreciably, this could have implications for monetary policy, especially if this unsettles inflation expectations. So far, such news has mainly led to a rise in long-term yields and has not affected spreads much. But closer monitoring of fiscal policy over the coming months and years will be needed. Hopefully, the revised fiscal governance rules will be respected by all Member States.

Q: When could the earliest impact of looser fiscal policy relevant for monetary policy occur?

A: I don't know exactly when this programme will start, but probably in September governments will start presenting their 2026 fiscal programmes to the Commission, so I suppose by then we will have some idea of medium-term fiscal policies. For this year, I'm not envisaging big changes, but in September, I look forward to seeing what they come up with. I think that's the first test.

Q: What about the characterisation of rates as ‘meaningfully less restrictive’ – do you see this as an ideal description, or would you have preferred something else? How long do you think this wording will remain valid?

A: Well, clearly with every rate cut that the ECB has made over the past nine months, monetary policy has been less restrictive. However, it is one thing being less restrictive when cutting rates from 4% to 3.75%, and it is another matter when you are cutting rates from 2.75% to 2.5%. And it would be increasingly meaningful if rates are reduced to an even lower level because you would be approaching even more the point where interest rates might become no longer restrictive.  For how long the wording is set to stay as such depends on the evolution of financial conditions, and how they play into the inflation outlook, the dynamics of underlying inflation and the strength of monetary policy transmission.

Q: Markets had previously seen two more cuts in 2025 after March – should they reconsider this?

A: Well, the higher uncertainty has certainly made it more difficult for markets to chart the way forward for interest rates. They will now need to sift through more thoroughly the incoming data and news from both sides of the Atlantic and make their bets accordingly.

Q: With rates at 2.5%, do you have an idea where you’d like to end? Should the ECB go below 2%?

A: Everything is possible, especially if financing conditions remain restrictive. The only certainty I have in my mind is that if the global trade environment is going to be characterised by higher barriers, whether in the form of tariffs or some other kind, and by retaliation between countries, then this is bad news for all economies. Such a demand shock usually also leads to deflationary forces in the medium term, which may require a stronger monetary policy response. Therefore, we need to see a holistic view of how global trade policy evolves, together with the fiscal policy response that may come along.

Q: When will you stop saying that past interest rate hikes are still transmitting? It’s been a year and a half since the last hike.

A: Economic literature shows that typically monetary policy takes about two years to feed through the economy which is why central banks rely on their medium-term outlook when setting the stance. If you take interest rates on outstanding loans, these were still on the rise, albeit they now appear to be peaking and with the interest rate cuts over the past nine months these could plateau and then begin to decline. Average lending rates on loans to both NFCs and households are at high levels and hence still restrictive. Indeed, although bank credit has been showing signs of recovery because interest rates on new loans are lower, credit growth still remains very much subdued and below its historical average.