By David Barwick and Marta Vilar – VALLETTA (Econostream) – If downside surprises led to a medium-term inflation outlook in the euro area below the European Central Bank’s 2% target, this could argue for another rate cut, according to ECB Governing Council member Alexander Demarco.

Demarco, who heads the Central Bank of Malta, stressed in an interview with Econostream on Monday (transcript here) that “with projections on track, there’s no motive for changing interest rates at this point,” but said policymakers must see whether more downside inflation surprises followed last month's.

“If inflation remains consistently below 2%—then there could be arguments for another rate cut,” Demarco said, adding that it would be worrying if January’s downside surprise were part of a pattern.

Demarco framed the ECB’s current monetary policy stance as appropriate and durable absent a material shift in the forecast path.

“As far as I’m concerned, I don’t see much scope for any change in interest rates for quite some time if things stay as they are,” he said. “I think we’re basically in a good place in terms of inflation and interest rates are appropriate.”

He tied any eventual policy move to whether repeated downside outcomes feed into staff projections, rather than to a single inflation print.

“If we start consistently undershooting compared to what staff projected last December,” Demarco said, and staff revise forecasts down so that “for a prolonged period, the medium-term outlook is below 2%, I don’t think that’s something you can ignore.”

On the January reading, Demarco said it was too early to draw broad conclusions, while underscoring the need to understand what drove the miss.

“I don’t want to put too much emphasis on January; it’s one month,” he said, noting the downside surprise in services and non-energy industrial goods. “After the January reading, we have to see whether this was a one-off or inflation will continue to surprise on the downside relative to our projections. That would be more concerning.”

Increasing Chinese imports were “something we need to monitor closely,” he said in this connection.

“One factor that could matter is China,” he said. “So, imports from China are growing, and that could put some downward pressure on inflation.”

He said staff were “very aware” of the issue in preparing projections, but suggested the magnitude remained uncertain.

“It’s not easy to quantify how big the China effect will be,” Demarco said. “But we are certainly seeing increased market penetration by Chinese goods in Europe… and their goods are usually cheaper, so there will be an impact on the price level.”

At the same time, he cautioned that disinflationary impulses from trade could be offset by other forces, including wage drift and energy.

“The key question relates to wage drift,” Demarco said. “We need to see whether it remains strong or fizzles out.”

He also noted that oil had risen relative to staff assumptions, arguing this could affect the inflation path in the opposite direction.

“Oil prices have also risen recently; they are now around USD65–70, while the projections were around USD62–64, so there could be some upside impact from that,” he said.

On growth, Demarco acknowledged that data had been “better than expected,” but said uncertainty remained a meaningful headwind.

“So yes, I can see there could be some more downside risks to growth, even though the data have been somewhat better than expected,” he said.

High uncertainty was already weighing on the economy via confidence and credit channels, he said.

“Uncertainty is still very elevated, and that’s not good for consumer confidence, investors, or banks,” Demarco said, adding that banks’ risk perceptions had increased and lending conditions had tightened “slightly” in the latest Bank Lending Survey.

“That’s something we need to look closely at if financing conditions tighten further,” he said.

Demarco said the ECB’s emphasis on “full optionality” should not be read as a bias toward hikes, and he rejected the idea that the evidentiary threshold differed by direction.

“I wouldn’t say that,” he said when asked whether the burden of proof for hikes was lower than for cuts. “I think the burden of proof is the same for both.”

While a cut could become warranted under persistent undershooting, monetary policy could not resolve trade-driven uncertainty, he said.

“The source of this uncertainty is essentially the weaponization of trade,” he said. “But in my view, a rate cut may become necessary, but it will not address trade uncertainty.”

Instead, he emphasized reforms that raise productivity and competitiveness.

“To address weaker growth or weaker competitiveness, you need structural reforms,” he said. “Lower interest rates than at present on their own are not going to help you export much more.”

On the euro, Demarco said recent appreciation against the dollar did not, by itself, constitute a major concern.

“Past studies suggest an equilibrium exchange rate could be around USD 1.20 to USD 1.25,” he said. “And even if we reach it, it’s not the end of the world.”

He argued that the bigger issue was what drove the move, and he described a stronger international role for the euro as an opportunity created by developments in the US.

“I don’t see that happening” in terms of the euro displacing the dollar, Demarco said, “but investors may rebalance their portfolios.”

“If you want the euro to have a stronger international role, some appreciation is a possible byproduct,” he reasoned.