MNI INTERVIEW: Growth, Politics Key To ECB Rate Path - Ex-BdF Economist
Growth and domestic uncertainty will be key to whether eurozone inflation proves sticky over the next few months, but there is little risk of any rebound in prices, former Bank of France economist Eric Monnet told MNI, adding that the chances of a July rate cut by the European Central Bank may increase following the French elections.
The bond market’s reaction to the French vote is uncertain, Monnet said in an interview, noting that even though a victory for the National Rally may not necessarily discomfort investors now comfortable with Italy’s right-wing Prime Minister Giorgia Meloni, the prospect of a government with a populist fiscal agenda could fuel volatility.
And while there are no signs of a fresh spike in inflation, the ECB remains watchful, said Monnet, who in May 2023 correctly predicted ECB interest rates would peak at 4.00%. (See MNI INTERVIEW: ECB To Hike To 4% - Ex-Bank Of France Economist)
“While inflation is higher than anticipated, it’s clear that it’s going down, and if there is a risk that it could go up again, I don’t see it. Of course it has to be watched, but the idea that inflation could increase significantly as a result of wages is not something that we see in the data,” he said.
“Whether inflation proves stickier in the months ahead than it has up to now will depend very much on Europe’s growth prospects as well as domestic uncertainty. This is definitely why the ECB is waiting before deciding its next move. But one thing we have learned in the last three years is that our understanding of inflation is very, very low.”
A National Rally victory in next month’s polls could mean the chances of a July cut have increased in the event that the markets react badly, said Monnet, now Director of Studies at EHESS and Professor at the Paris School of Economics.
TPI
While the chances that the ECB will consider itself obliged to buy bonds with its Transmission Protection Instrument are “higher than they have ever been”, it cannot technically be activated for countries such as France which are subject to European Commission excessive deficit procedures, Monnet noted. It could make purchases via Outright Monetary Transactions, but might prefer to cut rates first, he said.
“Cutting rates by 25 basis points in July is unlikely to have a huge impact on the economy or inflation, but would be worth doing just to see how the market reacts before trying to go into such heavy measures as TPI and OMT.”
Monnet stressed that a blowout between French and German bonds in the event of an extreme right or populist government is not “automatic,” and noted that the sell-off in UK bonds during the short-lived government of Liz Truss was prompted by specific policies.
MORE POLITICISED
Still, the election of populist governments and European parliamentarians may eventually change the relationship between national and European institutions and the ECB, Monnet said - with policies such as the central bank’s attempts to green the financial system possibly coming under strain.
“Unfortunately, I think the debate is going to become more politicised, whereas the ECB is run according to a balance of opinion, a balance of expertise,” he said.
“We may end up going back to the situation I and a great many people wanted to avoid, which is the European Court of Justice having the last word. If, for example, there is no longer an EU Green New Deal, where does that leave the ECB’s climate-related policy? Justifying these policies via reference to the secondary mandate may not be enough.”
Were inflation to return, populist governments could also reintroduce the kind of price controls seen during the Covid-19 pandemic and energy shocks without EU coordination, with implications for both inflation and national central bank independence.
“Might we see pressure for some national central banks to coordinate more closely with their governments, as is to some extent the case in Hungary today?” Monet asked.