By David Barwick – VIENNA (Econostream) – European Central Bank Governing Council member Martin Kocher on February 26 said that the emergence of an inflation risk could result in a very changed inflation situation in Europe that could require a modification of ECB monetary policy.

The Austrian National Bank, which Kocher heads, today approved his remarks, which were made at an event at the Swedish Embassy in Vienna last Thursday and thus before the conflict in the Middle East abruptly escalated. We reproduce his comments in full below:

“The euro area is therefore in an environment that is reasonably satisfactory as far as growth rates are concerned, but not exactly inspiring. … Could we grow faster if we used all of our potential and if uncertainty were lower? In the euro area, certainly yes. Is growth in that range bad? No, it is not. There is an English term from the fairy tale Goldilocks and the Three Bears. It refers to a situation where the Baby Bear’s porridge is just right, neither too hot nor too cold. And one could indeed say that we are in something like what used to be called in the United States, decades ago, a Goldilocks economy: not too little growth, not too much growth, relatively okay. But the uncertainty that currently prevails worldwide is really what continues to hold us back. And that uncertainty comes on top of structural factors. The structural factors are well known. In almost all of Europe in particular, aging societies are creating a degree of uncertainty because social systems are under pressure from demographic trends. Demographic change is being joined by technological change, which is also generating considerable uncertainty. And on top of that come relatively high energy costs and the trade tensions, which are weighing heavier on Europe than on other parts of the world. That is why we are seeing somewhat muted growth.”

“What gives us at the European Central Bank a certain amount of reassurance is the outlook for inflation. You can see the harmonized consumer price index, which is the measure usually used, and core inflation excluding energy and food. Both are very close to the desired 2%: slight deviations above and below, but in essence exactly where we want to be. That is why President Lagarde has used the term ‘good place.’ I will come back to that in more detail, but at the moment there are, in my view, no substantial risks that we would end up clearly below 2%. That said, there is of course a great deal of uncertainty, as with any forecast. The status quo means that if one of these risks materializes—and we could talk at length about which risks these are, whether an escalation of trade conflicts, the escalation of conflict in the Middle East as we speak, or other conflicts somewhere in the world that are relevant for the global economy, and so on—then it may become necessary to calmly reassess the situation and react very quickly, because the inflation outlook could then change significantly.”

“What is decisive, however, if one focuses on current developments, is services inflation. And this is not an Austrian phenomenon. The same is true for the euro area as a whole: roughly two-thirds to three-quarters of total inflation comes from services inflation. That means that what we are especially monitoring at the moment is not so much the exchange rate against the dollar—though that also matters and is important—but above all wage developments. Wages have a very strong influence on services inflation. In many services, the wage share is 40%, 50%, 60%, even 70%, depending on the service. That is why we have an EU-level Wage Tracker, which gives us a very up-to-date picture of collectively agreed wages. There are different measures we use to track wages in order to forecast how inflation is likely to evolve. But all of this currently points to inflation remaining around 2%, which is exactly the objective.”

“In essence, one can say that with rates around 2%, we are currently exactly where we want to be in terms of inflation developments, inflation expectations, and the inflation forecast. That has to remain the case going forward. That is why full optionality is so important. … So at present it really is the case that, with this level of interest rates, we are roughly where we should be given that inflation is in line with our target. Given the great uncertainty we face overall—geopolitical tensions, trade conflicts, and so on—full optionality, meaning no prior commitment to a particular rate path, is the better policy. It signals more clearly that we remain data-dependent than if we were to say in advance what might happen—whether rates go up, stay where they are, or come down again. … The best thing we can do is remain as flexible as possible should it become necessary to intervene.”

“Replacing the dollar was never the purpose of the euro. The euro was always intended as an important currency, but not as a global reserve or transaction currency on the scale of the dollar. Now, however, we are increasingly being pushed into certain roles. Europe is assuming greater responsibility. There is more interest from central banks outside the euro area in working with the euro, in using swap lines and similar facilities. That is all relatively new for the euro, because until now almost everything was conducted in dollars. So the question is: should we actively pursue that strategically? Or should we simply be prepared for it? My answer is: we should definitely be prepared for it. Last year the ECB published a paper on the international role of the euro that sets out a number of points. The essence is that we must equip ourselves institutionally and prepare to assume more responsibility. Should that mean actively seeking to compete with the dollar? I am skeptical as to whether that is even possible. The dollar’s strength rests on the strength of the American economy. That is difficult to replicate. But there is one important point. We often talk in theoretical terms about which currency is more important. Yet the dollar’s strength ultimately rests on a strong US economy. So if the European single market is strong, if we make progress on the capital markets union and strengthen the internal market, that also strengthens the euro. That is the key point.”