At what point is the fight againstinflation in the eurozone? According to the ECB's timetable, partly already incorporated by the expectations of the markets and financial operators, the first rate cut could get to June. Even for the governor of the Bank of Italy Fabio Panetta, the conditions for a possible path of easing in European monetary policy are on the horizon. “The numbers suggest that inflation in the euro area will soon be in line with the ECB's inflation target of 2%,” he notes Jakob de Haan, professor of Economic Policy at the University of Groningen and president of Suerf (The European Money and Finance Forum), one of the most influential European study associations on monetary policy which brings together the continental elite of economists, members of central banks and financial managers .
Professor de Haan, has the riskiest part of the European inflationary phase passed?
“In February inflation was 2,6%, the ECB's latest inflation forecast for 2024 is 2,3%, while inflation of 2025% is expected for 2. So yes, it seems that the period of high inflation will soon be behind us.”
Are there still any “tail risks”?
“These numbers are forecasts, so there is always the possibility that actual inflation could be different. In fact, over the last decade the ECB's forecasts have very often been wrong. When inflation was below target, forecasts suggested it would rise to 2%, but that wasn't the case. Similarly, when inflation was above 2%, the ECB initially expected the increase in inflation to be temporary. And when it became clear that it was not temporary, the ECB's forecasts underestimated actual inflation."
What global factors could keep monetary authorities on alert?
“Energy prices have a strong influence on inflation. The intensification of existing conflicts, or even the emergence of new conflicts, could lead to an increase in energy prices. Not only that, such conflicts could cause price increases through other channels as well. Today the Red Sea crisis leads to much higher transportation costs, which will impact consumer prices in the coming months. These supply shocks are the most difficult for central banks to manage, since their tools (interest rates) act through the demand side.”
For central banks, is inaction also a monetary policy choice?
“Not responding to the increase in inflation caused by supply-side shocks still runs the risk of so-called “second round effects”. For example, unions could still demand a wage increase to offset the price increase. If the increase in wages leads in turn to an increase in prices, a very dangerous vicious circle of price stability can occur. Central banks must always demonstrate that they are not willing to tolerate inflation being above their target for a prolonged period. Even at the cost of damaging the economy in the short term."
Despite differences compared to the USA, the stock markets continue to grow in Europe too, there are no significant problems on the employment front and the industrial economy has not suffered any collapses. When and how gradually will interest rates be cut?
“Several euro area countries have been or still are in recession, i.e. recording two months in a row of negative economic growth. Nonetheless, stock prices have risen, meaning financial markets are optimistic about future growth. Likewise, although unemployment has increased in several countries, it is still relatively low, reflecting tight labor market conditions. The ECB's interest rate hikes ultimately did not lead to a severe recession. In the labor market it is still possible that the risk of an excessive increase in real wages (nominal wages rise, while inflation falls) creates pressure on the demand side. In my opinion, therefore, the ECB should wait to cut interest rates until it is clear that this risk does not materialize. Once everything is clear, I would still suggest a very gradual decline in interest rates. I expect this to happen in the second half of this year, provided the international risks I described above do not materialize.”
In your opinion, what is the most important indicator to monitor in this specific economic phase to decide on the rate lowering strategy?
“Wage increases are the key indicator to monitor at the moment.”
Compared to the Fed, the ECB suffers from the problem of a monetary area with uneven fiscal policies. Could this also make the uniform return from inflation more difficult?
“Even in the United States, fiscal policy has not contributed to reducing inflation. Unfortunately, most of the time monetary and fiscal policies go in opposite directions, making the central bank's task of maintaining price stability even more difficult. In the euro area there is still no adequate coordination of national fiscal policies, it is almost impossible to guarantee that fiscal and monetary policies move in tandem”.
The debate on the neutral rate has become very topical again. What is your position?
“I think the concept of a neutral rate is not very useful for monetary policy purposes, I would never use it if I were a central banker. It is a theoretical construction, there is too much uncertainty about what it is to make it useful in the choices of policymakers”.
How do you evaluate the ECB's work so far?
“The ECB, like the Fed, initially underestimated the severity of inflation and this meant that it responded too late and too little. As an example, when inflation was already rising, the ECB continued to purchase assets. When it realized the gravity of the situation, the ECB took the right steps by increasing reference rates, but continued to reinvest in expired government bonds for too long. The ECB should have acted much more aggressively. Let's not forget that only at the end of 2024 will the ECB stop reinvesting the securities purchased under the PEPP".
Energy transition, green and increase in national spending to modernize European armies. How will they affect the price level in Europe?
“In principle, these problems mainly concern relative price changes. For example, if demand for defense goods increases, their price should rise relative to that of other goods. Relative price changes, as such, do not necessarily lead to an increase in the overall price level. Only if demand for several goods increases at the same time could the general price level be affected at the same time, in which case the ECB should respond."
