Written exclusively for InTouch Capital Markets
21st February 2018
By David Barwick
VILNIUS – Although there is reason to be somewhat more optimistic about the economic outlook the euro area is currently looking forward to, the European Central Bank needs to proceed with great caution, sticking to its reinvestment of proceeds from its asset purchases and leaving official interest rates alone until well past the purchase program’s end, Governing Council member Vitas Vasiliauskas said Monday.
Speaking to InTouch Capital Markets in an interview at his office, Vasiliauskas, who is Chairman of the Board of the Bank of Lithuania, appeared unconcerned by the euro’s strength as well as by the recent volatility seen on global stock markets.
Economic growth in the Eurozone is subject to a somewhat better outlook, he agreed, calling himself “a little bit more optimistic on the evolution of the balance of risks to growth.”
However, the improved optimism doesn’t yet justify a policy change, “because the situation is still complicated,” he insisted. “We need to be patient and cautious about making any decision.”
The ECB is absolutely determined to avoid the risk of having to backtrack on a premature change of course, he said.
The updated staff macroeconomic growth forecasts to be announced at the ECB’s next policy meeting, which takes place on March 8, are likely to reflect policymakers’ cautious approach, he suggested. While there is “no reason to see a worse situation,” any improvement is likely to be incremental at best, he said.
In December, when the ECB’s projections were last revised, they called for real GDP growth of 2.3% this year, 1.9% next year and 1.7% in 2020, representing upward revisions of 0.5 point and 0.2 point to the 2018 and 2019 forecasts that had been issued in September.
December’s 2020 forecasts were the first for 2020 and are of particular importance as they are most indicative of what the ECB’s medium-term expectations are. The ECB seeks to look through short-term developments and focus on the mid-term in setting policy.
The inflation outlook as well is “broadly the same” as it was in December, Vasiliauskas said. The decline in annual Eurozone HICP to 1.3% in January from 1.4% the previous month was mainly due to base effects in connection with energy price developments, while core inflation, which strips out the more volatile components, actually picked up a bit by some measures, he noted.
Current staff projections from December foresee inflation in the euro area at 1.4% in 2018, 1.5% in 2019 and 1.7% in 2020, versus the 1.2% for this year and the 1.5% for next predicted three months previously.
An increase next month in the HICP number for 2020 could suggest that the ECB sees medium-term inflation within striking distance of its goal of close to but below 2%. Still, even such a development would not engender an imminent policy shift, as authorities need to be of the view that price stability has been sustainably regained, implying a number of months of consistently satisfactory readings.
Vasiliauskas left no doubt about the high importance monetary authorities attach to the continued reinvestment of principal redemptions on securities purchased under the asset purchase program. Like Draghi, he called ECB signals to that effect “a fundamental part of our forward guidance.”
“It is very clear that reinvestment should continue beyond the end of the program,” he said.
Similarly, there is no question about sticking to the envisioned sequence of policy adjustment, according to which interest rates are to remain at the present level well past the end of the net asset purchase program, he said.
Vasiliauskas downplayed recent volatility seen on equity markets as a “normal reaction” to evolving expectations of inflation: “Everybody now expects higher inflation and higher risk-free rates, and that naturally makes risky assets less attractive. So we can expect higher volatility in the future as well.”
In that sense, he added, the volatility merely corroborates the ECB’s own forecasts of higher future inflation.
The current exchange rate – the euro was at 1.24 to the dollar as he spoke – is “nothing special” if seen in historical context, he said. In general, the impact of foreign exchange movements on inflation has declined, he noted. “We don’t currently see anything to be concerned about in this regard.”
Like most of its counterparts in other developed economies, the ECB, he noted, does not target the exchange rate, merely taking it into account for policy decisions as one factor among many, albeit an important one.
ECB President Mario Draghi has recently called the exchange rate, which he cites as one of various downside risks to growth, “a source of uncertainty which requires monitoring with regard to its possible implications for the medium-term outlook for price stability.”
As to the new leadership at the U.S. Federal Reserve, where Jerome Powell took over the chairmanship from Janet Yellen earlier this month and is considered by some observers to be somewhat more dovish than his predecessor, Vasiliauskas said he anticipated no significant policy change, “bearing in mind he’s been at the Fed since 2012 already.”
“We are reasonably certain of a continuation of the current policy trend,” he added.
Vasiliauskas confirmed unreservedly President Draghi’s assertion at the January 25 press conference that the Governing Council hadn’t discussed cutting the link in the ECB’s forward guidance between the asset purchase program and inflation. At the time, Draghi reported that “the only discussion that took place was about the need to have a discussion,” which is “to take place in the early part of this year.”
The early part of this year, Vasiliauskas clarified, means the first half. “I am slightly optimistic regarding the economic situation and the outlook for medium-term inflation, but all our decisions are based on economic data and follow deep discussions at the level of the Council. And the present environment obligates us to be patient and cautious about sending signals to the market. That is why my view is quite conservative.”
As for Draghi’s comment at the January press conference that “most [Governing Council] members reiterated the steadfast commitment to reach our objective,” the word “most” was not meant to suggest any weakening of some Council members’ attachment to their price-stability mandate calling for medium-term inflation close to but below 2%, according to Vasiliauskas.
“I don’t see any substantive differences among Council members regarding our mandate, which we all continue to take extremely seriously,” he explained.
While agreeing that Eurozone member states have by no means all taken full advantage of the window of opportunity provided them by easy ECB policies to implement reforms, Vasiliauskas said that this would not deter monetary policymakers from eventually withdrawing support.
“We can’t buy time forever,” he said. “We all have to do what we have to do. It will come to an end.”