By Marta Vilar and David Barwick – WASHINGTON (Econostream) - Following is the full transcript of the interview conducted by Econostream on 16 April with Alexander Demarco, Governor of the Central Bank of Malta and member of the Governing Council of the European Central Bank:

Q: Governor, is it fair to say that the ECB has become more dovish lately?

A: The effects of the war are largely yet to come. There have been some direct effects, because inflation in March went up to 2.6%. But if you look at underlying inflation in March, it actually went down slightly and was still pretty much in line with what we had projected. Also, it is still early for indirect effects. There are some signs; for example, anecdotal evidence suggests airfares have gone up. We may see more of that later on, in the coming weeks or months. But the data so far has not been alarming.

We are also starting from a good place. Inflation was around 2%, and the interest rate is around neutral. So the situation is very different from what it was in 2022.

That does not mean there are no risks. It depends on the intensity and duration of the war, which does seem to be dragging on. One thing I will be looking at very closely this month is the corporate telephone survey on selling prices. We have to see whether businesses are planning to raise prices by more than previously anticipated. That could signal indirect price pressures from higher energy prices down the line, especially if oil prices remain high for longer.

Another thing to watch is inflation expectations, which so far seem to be well anchored. Our starting point also confirms our credibility as a central bank, which may put us in a better position than some other advanced economies. So, we start from a good position of credibility, but we definitely need to monitor the situation, because things can change quickly, especially since the memory of the rise in inflation following the war in Ukraine is still fresh in people’s minds.

Q: It has been clear for a while that April is unlikely to bring a move. But even June seems subject to question. Could it be that you keep looking through things and only hike later?

A: In April we will still only have March inflation data, so from that point of view there will not be much additional information. Though as I said, the corporate telephone survey could give some indication of where prices may be heading.

By June, we will have a new set of projections and more information, including April and May inflation. That will be interesting, especially for underlying inflation. Headline inflation will remain well above 2% for sure, but the key thing to look at will be underlying inflation, to see whether there are spillovers into services and broader inflation. So given higher uncertainty at the moment, June is the more natural horizon for judgment this time.

Still, there could be real effects coming in. If the Strait remains closed, we could start experiencing fuel shortages and other supply bottlenecks, and that would have real effects. We also have to watch fiscal support. My country has been subsidizing energy since Covid, and now, after the war, not only the government but even the opposition is supporting that policy. Other countries are also thinking of implementing support measures to mitigate the increase in energy prices.

Q: Besides exogenous developments that we all see, is there anything the ECB can learn before the April meeting that could produce a hike?

A: The April meeting is not very far off, so other than the corporate telephone survey, there aren’t many other signals that can come from the data itself in the next two weeks. But the corporate telephone survey results would have to really show significant price hikes coming along to require action.

Q: If you saw companies thinking of raising prices, would you still prefer to wait until June brought additional information, or would you want to nip it in the bud and act early?

A: It would depend on their responses. If they said costs were increasing significantly and they could not absorb them and would have to pass them on to consumers, then I would not exclude a case for acting.

But if they do not intend to implement a significant increase in prices, we could look through that. Economic activity might also weaken more if there were shortages and supply bottlenecks, and that could also have a dampening effect on inflation, including via wages.

So we have to wait and see. On wages, the labor market has softened a bit and employment growth has slowed down. It is not as yet a soft labor market, far from it, as unemployment is still at historic lows, but at the moment I am not really seeing strong pressures to raise wages quickly. So I do not really see much pressure to be hasty and raise rates. I think we need more solid evidence that underlying inflation is really moving in the wrong direction.

Q: Might we get through this entire shock without hiking rates at all?

A: It would be presumptuous for me to say that, because I do not know how the war is going to pan out. To be honest, we may seem to be moving toward the adverse scenario at the current juncture, so I am not sure that we will get through this episode without any rate hike at all. Energy prices are going to be higher than the pre-war level for longer. Things can change, but I am not seeing them change in the right direction. Still, everything is possible. If there were some agreement tomorrow and this all stopped, then there might be no need, even though restoring the infrastructure and hence supply to pre-war levels requires some time.

Q: At what point does the shock become persistent, as opposed to something to look through?

A: The delivery of oil supplies would clearly be central. Supply constraints or bottlenecks are really the biggest issue. The longer the Strait remains closed, the more likely it is that the impact on the real economy and on inflation will grow. Typically, when you have supply bottlenecks, prices go up and activity weakens.

Q: At the next meeting, how should the introductory statement look? How should President Lagarde communicate the ECB view?

A: In my view there is not much need to change anything in the introductory statement. The level of uncertainty is very high, so the meeting-by-meeting approach, which was sensible anyway, is even more so now. So, I do not see any need to change the statement at this point, or the broader communication. The point is to leave everything open and retain optionality. Of course, it is not full optionality in the sense that interest rates can go down. The consensus is that easing is off the table. But the optionality between raising rates and keeping them unchanged, that was the message we gave last time, and I trust that is how it was understood. If there are signals that inflation is going to rise above our target over the medium term, then we would have to respond.

Q: And Madame Lagarde needs to be careful not to create the impression that a hike in June is a done deal, right?

A: Right. There is no done deal, neither for April nor for June. We are looking for spillover effects from oil prices into the prices of goods and services. So far, beyond airfares, we have not seen much. But it is still early, and the rest of April and then May will tell us more, apart from indicators of inflation expectations.

Q: Speaking of inflation expectations, which measure matters most to you in practice?

A: They all have their value. Markets like the five-year forward, but you have to look at all the indicators. Consumer expectations are also important, because they tell you what consumers are actually feeling, and that can translate into wage pressures if consumers feel inflation has gone up. It is also important to monitor food prices. So far things look benign. Again, the situation is quite different from two years ago, but we have to see more, because consumers tend to focus on the goods they purchase regularly, such as energy and food, and those tend to influence their inflation expectations more than for example other goods or services do.

Q: Do you see markets as having done some of the ECB’s work for it by tightening financial conditions, and does this buy you time?

A: Market conditions have tightened. Ten-year bond yields have increased quite a bit. German Bund yields are over 3% now, something like 50bp higher than they were before. So yes, that makes things a bit easier in the sense that it could restrain demand somewhat. But it does not mean that we can do nothing just because the market itself has tightened. Part of the market tightening is probably due to expectations of more fiscal expenditure. If such tightening impacts appreciably demand, then the argument for a much tighter monetary policy could weaken.

Q: Markets have a couple of hikes priced in for the rest of this year. Would you endorse that?

A: If the adverse scenario materializes, that is a reasonable expectation.

Q: How long can markets be convinced to do some of the work before you act?

A: Markets have stabilized a bit, and for the time being I do not really see a good reason why yields would need to rise much further, unless fiscal policy may turn out to be more expansionary than anticipated.

Q: And if it does come to a rate hike, would it inevitably be limited to 25bp?

A: There is absolutely no reason at this point to consider anything larger. In recent years central banks have generally moved in 25bp steps. That seems to be the norm, barring something catastrophic.

Q: How important are projections meetings in terms of timing a move?

A: As we always say, the meetings that do not have new projections are not automatically discounted. The absence of projections does not mean there can be no action.

Q: Do you think the discussion about the balance sheet could start at the next meeting?

A: I would expect that to start later this year, but don’t exclude an earlier beginning.

Q: Will the ECB provide an update of the outlook in conjunction with the April meeting?

A: I don’t expect any major update. There could be some update related mostly to oil, but oil prices are still within the range of what we had in the adverse scenario and the baseline. The exchange rate has remained broadly stable; it has appreciated a bit lately compared to the baseline, but nothing dramatic since the March projections in terms of the underlying assumptions. So, I do not expect any big differences from the assumptions we have already seen, but it could be that we are veering towards the adverse scenario.

END