Interview with ECB Governing Council member Stournaras: „There is a risk of inflation falling below the 2% target“

PLATOW editor Jan Mallien in an interview with Yannis Stournaras, Governor of the Bank of Greece and Member of the ECB Governing Council.

Governor Stournaras, the latest economic data for the eurozone, such as the purchasing managers‘ indices, have been disappointing. How concerned are you about this?
The figures indicate that growth in the eurozone has been curbed and that economic momentum is slowing. The purchasing managers‘ indices fell to a five-month low in July. There are also other warning signals.

What do you mean?
I’m worried that there are no signs of a recovery in manufacturing and industrial production. The increasing geopolitical fragmentation also harbours risks. The decline in business confidence in the two largest economies in the eurozone, Germany and France, is particularly worrying.

This sounds as if the ECB will cut interest rates in September?
Our decision depends on the data. As President Lagarde has emphasised, we don’t just rely on individual data points. We take all available information into account.

Which data do you pay particular attention to?
It is crucial that the incoming data, especially on wages, confirms that inflation will return to the target level of 2% in the medium term. The ECB projections on inflation and growth in September are important. If inflation continues to fall as expected, gradual rate cuts would be appropriate in order to strengthen economic momentum.

In its June projections, the ECB assumes real GDP growth of 0.9% for 2024. Is this still realistic?
The preliminary GDP flash estimate for the second quarter 2024 is at 0.3 per cent, slightly lower than expected.  At the same time, the incoming data suggests that there are still downside risks to growth given the high level of uncertainty. The eurozone economy is expected to continue to grow over the next few quarters, but growth could be lower than expected in June.

What does this mean for inflation and monetary policy?
The renewed signs of weak economic activity and the high level of uncertainty will very likely dampen inflation more than had been expected. This suggests that there is a risk of inflation falling below the 2% target in the medium term.

You recently said that you expect two further rate cuts this year. Do you now expect more cuts?
I still expect two rate cuts this year if disinflation continues as expected. We are on the right track. In addition, growth is weaker than expected, which also speaks in favour of interest rate cuts.

An important point of reference for determining how many interest rate cuts are necessary in the future is the neutral interest rate, where monetary policy neither supports nor slows down the economy. Where do you think this lies?
The existing estimates are subject to considerable uncertainty. Philip Lane recently estimated it at nominal 2%, Isabel Schnabel also assumes a nominal range of between 2 and 2.5%. I am inclined to agree with these estimates overall.

According to the ECB’s June projections, the inflation rate in the eurozone will reach the target of two per cent by the end of 2025. If monetary policy is to be consistent with the projections, the interest rate would have to be lowered to 2.5 per cent by then, if this is the neutral level.
Yes, exactly, but keep in mind the associated uncertainty.

But then quite a few rate cuts would be necessary this year and in 2025. So far, the ECB is taking its time. Do you not trust your own projections?
Our projections assume that inflation will fall smoothly and quickly. But the path remains bumpy in an environment of great uncertainty. The July reading of 2.6 per cent (flash estimate of euro area inflation) fits into this picture, and is in line with our projections. That is why we are proceeding with caution in our decisions.

What does that mean?
We should be concerned that we could overshoot our inflation target, but also undershoot it, as there are signs of a slowdown in growth.

Do you see risks in both directions?
In my view, the risks are now balanced. We should be equally concerned about overshooting and undershooting the inflation target.

So far, the Governing Council members have been more concerned about inflation being too high. Your Council colleague Isabel Schnabel, for example, has once again warned that the last mile in the fight against inflation could be the most difficult. Do you share this assessment?
Inflationary pressure has eased significantly since our last rate hike in September 2023. According to our June projections, inflation is well on the way to approaching the inflation target of 2% by the end of next year on a sustainable basis. And if we exclude the base effects in the energy sector, inflation has now been falling continuously for many, many months.

Many experts are worried about the high inflation rate for services. You take a more relaxed view. Why is that?
Service prices and wages react late to falling inflation. It can therefore be misleading to place too much weight on current data. Wages have risen sharply in 2024 to compensate for the loss of purchasing power in recent years. However, forward-looking indicators point to a decline in wage growth in 2025. In addition, lower profit margins could cushion wage increases to a certain extent. Finally, our target of 2 per cent relates to overall inflation.

You mentioned the high level of uncertainty. The elections in France have contributed to this, and the vote in the USA is coming up soon.  What impact will this have on the financial markets?
The markets always react to political news. The elections in France led to somewhat higher volatility, but this has largely calmed down again. The US elections, on the other hand, could have a lasting impact on the global economy.

What exactly do you mean?
If the threatened tariffs become reality, I fear an even greater segmentation of the global economy and more stagflationary pressure, i.e. a combination of inflationary pressure and economic weakness.

Let’s talk briefly about the ECB’s planned strategy review, which is due to start soon. What do you expect from it?
The economic environment has changed significantly since the last review in 2021.  At that time, we assumed that our key interest rates would often be close to the effective lower bound, which would limit the impact of monetary policy. Several shocks have since led to a surge in inflation. We need to ensure that our strategy is effective in both high and very low inflation. Our inflation target of two per cent remains unchanged.

Some Council members argue that trends such as the ageing of society or the green restructuring of the economy tend to lead to higher interest rates. Do you agree with this?
The debate is related to the neutral interest rate, which we have already discussed. This is an unobserved variable, but we know that it is influenced by various factors, such as productivity growth, population ageing, globalisation, and the level of government debt. At the same time, artificial intelligence and the green transition are expected to play an increasingly important role. There is clear evidence that the neutral interest rate was trending down before the pandemic. I believe that it will be close to, but above, pre-pandemic levels in the future – somewhat above zero percent in real terms.

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