MNI INTERVIEW: ECB Rate Peak Set To Be Lower-Gonzalez-Paramo

Eurozone financial conditions are tightening following the collapse of Silicon Valley Bank and the forced takeover of Credit Suisse by UBS, a former member of the European Central Bank’s executive board told MNI, adding that the ECB still has work to do to tame inflation but that the peak in rates is now likely to be lower.

Recent banking turmoil will intensify what “was already being observed” as lenders become more cautious about making loans, Jose Manuel Gonzalez-Paramo, who sat on the executive board from 2004 and 2012, said in an interview.

While tighter financial conditions have a similar effect to an increase in interest rates, he considered it too soon to quantify this equivalence, which will vary day-by-day depending on market conditions.

“If you ask five different experts you will get five different answers, because there are many ways to calculate that number,” said Gonzalez-Paramo, admitting that it would allow a lower peak in rates than previously expected.

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But the ECB still has work to do to bring down inflation and perhaps two further rate increases are likely, he said, though he did not want to provide any estimate of their likely magnitude, given the “very fine calibration” any hikes will require.

Clear communication from ECB president Christine Lagarde last Thursday and reassurances that the precedence of European AT1 bonds over equity will be respected has helped to calm markets and reduce volatility, allowing the central bank to focus on inflation again, he said. (See MNI ECB WATCH: Rates Up 50Bps With 'Ground To Cover' - Lagarde)

Gonzalez-Paramo said he agrees with Lagarde that there is no trade-off between price and financial stability, with each reinforcing the other.

“Not acting against inflation creates instability. And rates are only effective if there is stability,” he said, adding that recent events are a “wake up call” regarding the effect of higher rates but that it was predictable that something should have buckled under the strain.

“What was most surprising was that it should have occurred in the banking sector and not in the non-banking sector,” he said.

Asked about comments by Lagarde that the ECB has yet to decide whether it could buy bonds under its Transmission Protection Instrument in response to financial instability, Gonzalez-Paramo noted that any consideration of this matter is still very preliminary, but that the tool was created in the tradition of the “whatever it takes” approach to protecting monetary union of former president Mario Draghi. (See MNI INTERVIEW: Major Instability Would Force Rate Cuts-Papadia)

For the moment, core inflationary pressures are at worrying levels and the performance of this metric between now and June will be key to future rate decisions. Sliding energy prices suggest that core inflation will ease as rapidly as it rose, which would make life easier for the ECB, but Gonzalez-Paramo noted that such symmetry is not guaranteed.

In the longer-term, structural changes as globalisation makes a partial retreat and more difficult demographics may make it harder to keep eurozone inflation at 2%, he admitted, though he insisted that this does not mean that the ECB’s 2% inflation target is no longer appropriate. Technology should provide some disinflationary impetus, he said, adding that central banks that change their targets lose credibility quickly because “it shows that we are not capable of meeting our commitments.”