MNI INTERVIEW: ECB Needs Caution As It Nears Neutral - Demarco
MNI (WASHINGTON) - The neutral rate of interest in the eurozone lies in the range of 2% to 2.5% but is very difficult to measure with precision, while geopolitical uncertainty means that the European Central Bank should be cautious as it approaches this level even as a weakening outlook for inflation adds to the case for cuts, Bank of Malta Acting Governor Alexander Demarco told MNI.
“If the new information continues to confirm the trends that we have been observing in the past couple of meetings, then the likelihood of a rate cut in December is in my view very high,” Demarco said in an interview in Washington as the IMF held its autumn meeting.
But geopolitical uncertainty means “it is important not to be hasty and avoid over-reactions” in the move towards neutral, Demarco said, stressing that this would reduce the risk of having to backtrack on a cut, which “may end up confusing markets”.
Still, the case for further cuts would strengthen still more if growth as well as inflation projections are revised downwards, as it would indicate that demand pressures are likely to exert less inflationary pressures than previously anticipated, he said. (See MNI SOURCES: ECB Officials See Rate Expectations As Stretched)
The high degree of geopolitical uncertainty means that the ECB’s data-dependent and meeting-by-meeting approach remains appropriate, but if this were to subside the ECB “could put more weight on the inflation outlook in setting the stance,” he said.
“The Governing Council is confident that the ECB is on the right track in achieving its price stability objective, but uncertainty surrounding the economic environment is still high and therefore we still need to act with caution going forward so as not to derail the disinflation process,” he added.
UNDERSHOOTING RISK LOW
The risk of undershooting the 2% inflation target is still low despite the rate of increase in prices having fallen to 1.7% in September, said Demarco, noting that underlying inflation is well above 2%, and distant from its average 1.7% of the past 20 years. (See MNI INTERVIEW: Risk ECB Undershoots Inflation Not High -Vujcic)
The ECB should continue to “monitor trends in inflation, and also the implications on inflation of trends in output growth,” he said.
Asked about the ECB’s December projections, in which analysts expect downward revisions for growth and inflation, Demarco noted that the key thing was to examine the drivers behind any changes to the outlook. It is still too early to know what these might be, he said.
The recent “upward surprise” in savings data that ECB policymakers could result from uncertainty climate regarding conflicts in Ukraine and the Middle East, but could also reflect the need of households to rebuild their savings in real terms following a period of high inflation, as well as the higher incentives to save with more favourable interest rates on term deposits and other savings instruments, he said.
Is still too early to know whether a shift to greater consumption of services in relation to goods is a “structural or transient” effect of pandemic changes to consumption, though this “could have some impact, at least in the shorter term on inflation rates of these component,” Demarco said.