FRANKFURT — Fears that inflation will continue to race upward for years to come are unfounded, Bank of Spain Governor Pablo Hernández de Cos said Tuesday, suggesting that rock-bottom interest rates could continue in the eurozone.
Even as other major central banks have started to tighten policy to rein in surging prices and colleagues on the European Central Bank’s Governing Council warn that inflation may come in stronger than expected, de Cos suggested the opposite may be the case.
Last week, the European Central Bank announced that it will phase out its pandemic crisis asset purchase program, dubbed PEPP, by the end of March, but did not signal an end to other purchases or any rise in interest rates next year. It also made a sixth straight upward revision of its quarterly inflation projections.
The one thing that could keep inflation higher than projected for longer is wage development, de Cos told POLITICO in an interview. But the odds are in favor of projected wage trends being too high rather than too low, he added.
“The risks that we will see inflation higher than projected in the forecast published on Thursday depends crucially on wages. It’s very difficult to imagine a scenario of inflation in the medium term being more dynamic than in our current baseline without seeing a relatively strong wage growth,” de Cos said.
“In some sense, there is a kind of positive judgment on wages that we are not naming second-round effects, but [that] are embedded in the forecasts,” he said, pointing out that the wage growth path projected for 2022-2024 is higher than 3 percent, which is significantly above (around 1 percentage point) what the last decade bore out.
“This is something that yet has to materialize,” said the Spaniard, who also serves as chair of the Basel Committee on Banking Supervision. This indicates a real chance of inflation staying below the 1.8 percent the ECB has estimated for 2023 and 2024, he noted.
ECB policymakers had a heated debate about the inflation outlook at a meeting last week. More hawkish policymakers fear the central bank remains too relaxed about the potential of inflation continuing to surprise on the upside and are calling for acknowledgment that inflation risks are skewed in that direction.
De Cos pointed to the ECB’s alternative scenarios, in which it forecast developments under more adverse or positive economic developments.
The outcome of the so-called mild scenario brings inflation to the ECB’s target — rather than well above it — by 2024, while the adverse scenario under which the pandemic further slows growth sees inflation falling below the target, to 1.3 percent.
De Cos also said he sees no solid evidence that the Omicron coronavirus variant will add to inflation pressures over the medium term, instead highlighting uncertainty: “Omicron will have a contractionary impact on demand and this could actually translate into lower prices. But there will be also an impact on supply, and this goes [in] the opposite direction.”
The risks to growth, at least in the short term, go beyond the recent downward adjustment in growth forecasts, which were finished in late November and therefore don’t fully reflect Omicron’s impact.
“We are now seeing that many governments worldwide are taking decisions, which basically limit mobility, and you might think that this would have an impact on consumption and tourists flows,” he said. Even if consumers and firms have become more agile in adjusting to these restrictions, “this does not mean that the impact on growth is not going to be significant.”
As a result, de Cos said he considers interest-rate hikes next year “very unlikely,” setting the ECB apart from the Bank of England and the U.S. Federal Reserve. The Bank of England raised rates in December and the Fed signaled a slew of hikes next year.
“We decided to end our PEPP program as anticipated by [the] end of March. At the same time, we are also making the point that if there is a pandemic-related need, we might be in a position to restart net asset purchases through the pandemic program.
De Cos emphasized the ECB is ready to adjust policy in either direction as the situation warrants.
Pain in Spain
Even if de Cos is less worried about eurozone inflation staying high than some of his colleagues, he said surging prices in Spain are set to be a significant drag on the national economy.
Spain has suffered the sharpest contraction of any eurozone member country during the pandemic and has recovered more slowly, while inflation is outpacing that of most other member countries. Spain’s economic output in the third quarter was still 6.6 percent below pre-pandemic levels, compared to only 0.3 percent in the eurozone.
“Even if employment has performed relatively well in the Spanish economy, we did comparatively worse in terms of household disposable income, and consumer confidence,” de Cos said. Surging electricity prices are estimated to shave off 1.5 percentage points of growth this year and next, if energy prices remain at the levels markets expect.
Other key reasons for Spain’s comparatively weak performance are that the country has been hit harder by the pandemic and is more dependent on tourism, particularly from Britain. Weak investment performance, particularly in the key automotive industry which — closing the circle — is suffering from low demand from car-rental firms to replace their fleets, also played a role.
Another factor, which de Cos suggested was not sufficiently discussed, is “that the energy price shock is a negative supply shock, that conveys a deterioration of the terms of trade for both Spain and the eurozone, as energy net importers of gas and oil. This means that our real incomes are falling, which has an adverse impact on aggregate demand.”
To de Cos, these headwinds and the continued pandemic are good reasons to remain cautious going into the new year.
“The main policy uncertainty that we will have to face is related to the pandemic and its economic effects,” he said.
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