Darkening of mood a “big problem”, says the ECB’s chief economist – POLITICO

FRANKFURT – The recent slump in economic sentiment is a matter of major concern as it suggests the euro zone economy could be hit hard by Russia’s war on Ukraine, according to European Central Bank chief economist Phillip Lane.

In an interview with POLITICO on Monday, Lane pointed to “quite significant and substantial” declines in sentiment indices for both consumers and businesses, calling them a “major concern” for ECB policymakers. Last week, euro-zone consumer sentiment posted the second-largest decline on record, while business sentiment exit expectations collapsed.

Inflation is rising up front and in the middle, which Lane bluntly summed up. “Europe may have to get used to higher prices,” he said, but added that most inflation would “disappear”.

“The momentum – where inflation is higher each month than the previous month – is going to slow down in our view,” he said. “Inflation will come down later this year and be much lower next year and the year after than this year.”

If the deteriorating growth outlook risked inflation falling below target, it could force the ECB to say it is ready to change course on its plans to end its massive bond purchases. Lane reiterated that position on Monday, saying the ECB would respond flexibly should the war wreak even greater havoc on the economy than forecast.

The fact that inflation in the euro zone has almost hit 6 percent – almost triple the ECB’s target – prompted the Governing Council to do so earlier this year accelerate its exit from large-scale asset purchases. At the time, the ECB also changed its monetary policy guidance to say it would raise interest rates “sometime after” the end of asset purchases, rather than shortly thereafter – signaling that it will not hike rates in a rush.

Lane also touched on the latest from the ECB staff projections, in which the economy grew 3.7 percent this year and inflation averaged 5.1 percent. He declined to say whether the latest data renders that forecast obsolete. However, he noted that some indices are pointing to upside risk to energy prices, while others are pointing to downside risk to growth.

Any revision of the growth and inflation outlook at the ECB’s June meeting would have to mean “a significant decline in the medium-term inflation outlook” for the ECB to continue its asset purchases beyond the third quarter of this year, Lane added.

Whether the central bank’s first rate hike in over a decade would follow later this year depends on the incoming data, he said.

“We’re trying to make it as clear as possible that monetary policy will be data-driven,” Lane said. “There are scenarios where it would be appropriate to start normalizing interest rates later this year. And then of course there are scenarios where it might be appropriate to move at a later date.”

Lane pointed to a high level of uncertainty about the economic outlook amid the war, the recovery from the pandemic shock and recent twists and turns in the pandemic – such as China’s call to impose a strict lockdown on Shanghai.

“It’s not helpful to give a calendar guide under these conditions,” he said. “The commitment is that we ensure our monetary policy actions are on the right track to ensure inflation stabilizes at 2% over the medium term.”

too rosy?

Lane defended the ECB’s latest staff forecasts, which include alternative scenarios that assume an immediate boycott of Russian gas and oil. These forecasts had been criticized as far too optimistic. Even in the most difficult scenario, the ECB expects the euro zone to grow by 2.3 percent this year and next.

The ECB’s forecasts stand in stark contrast to those of private sector economists and the federal government, who insist that an immediate ban on oil and gas would propel Europe into the next recession.

In fact, Chancellor Olaf Scholz on Sunday evening knocked out on economists who have hinted that the eurozone economy could survive an immediate boycott of oil and gas. It is not only “wrong” but “irresponsible” to base such proposals on “a mathematical model that doesn’t really work in the end,” he told German television.

Lane tried to distance himself from the debate.

“Let’s be clear that these were two scenarios, but they were specifically not intended to be tail scenarios,” Lane said of the ECB staff’s adverse and severe scenarios. The severe scenario assumes that the disruption in energy supply is only temporary and that Europe will have found an alternative source of supply by the end of the year.

“If you enforce a longer disruption in energy supplies, then you would have a more significant drop in GDP,” he said.

Lane also stressed that the eurozone is still emerging from the recession caused by the pandemic, so the “significant” impact of the war on the economy – assumed in all scenarios – will be partially offset by a strong recovery from the recent trough , as consumer spending will be delayed purchases.

“The key issue…is that we have created a monetary policy framework with flexibility and optionality that is essentially explicitly designed to respond to whatever develops in relation to the medium-term outlook,” Lane said.

Fiscal Players

Lane also commented on the proposed reform of the Stability and Growth Pact, the fiscal architecture underpinning Europe’s economic governance, which is set to be changed amid calls for more flexibility from countries like France and Italy.

Lane pointed to the key importance of the spending rules, which required budget deficits below 3 percent of GDP. At the same time, “you still need a debt anchor,” he added. “The countries with high levels of debt need to see those debt ratios come down.”

While current rules require countries with high levels of debt to progressively reduce their debt by 5 percent, eventually reaching a 60 percent-to-GDP ratio, Lane proposes a “softer” reduction of 3 percent instead of the current coefficient of 0, 5 percent before.

“The pandemic has shown the value of joint European funding, be it SURE or Next Generation EU,” he says, referring to the Commission’s pioneering recovery programs during the pandemic. The climate in particular, but you can also think of other dimensions of it.”

“[Any] Responding to carbon shocks with forms of carbon finance, either the SURE dimension or the EU next-generation, should be part of Europe’s broader fiscal recipe,” he added.


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blank Darkening of mood a "big problem", says the ECB's chief economist - POLITICO

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