FRANKFURT, Oct 8 (Reuters) – The following are the highlights of a Reuters interview with ECB policymaker Primoz Dolenc. For an interview story, click here.
ON INFLATION
“Headline inflation rose to 3.8% last month, above our projections, largely reflecting developments in energy prices. At the same time, core inflation has remained relatively stable, suggesting limited pass-through to underlying inflation components, particularly services. While the headline figure is elevated, the more stable behaviour of core inflation provides some reassurance that broader inflationary pressures remain contained.
The indirect effects of energy prices are there and quite visible. We see from PMI figures and output prices that energy inflation was transmitted also to manufacturing and services. As regards to second-round effects from high energy inflation to wages, we haven’t seen that yet. And this is an important element at our decisions, since second round effects cause more stubborn inflation.
There are two crucial differences between the post pandemic period and the current inflation: First, the labour market is not as tight as it was three or four years ago. And the second is fiscal policy, which was exceptionally expansionary in the pandemic period.
ON INFLATION OUTLOOK
Of course, risks to the inflation outlook are to the upside: energy prices, potential second round effect, the prolongation of the conflicts, and even better economic performance. Low gas storage levels are also a risk because the pass-through of wholesale gas prices to retail prices has accelerated in the last couple of years. However, it is worth mentioning that gas prices are much lower than they were at the outbreak of the Ukraine crisis. Finally, there’s food inflation, which has been surprisingly low. But given all the pressures from the energy prices, heat waves, and El Niño, we might expect an upward trend in food inflation again.
ON POLICY
Persistently elevated inflation that we see in our September projection and the lack of resolution of conflicts in the Middle East, Ukraine and elsewhere, supports the case for moving policy rates towards a more restrictive territory. But when and by how much we will determine on a meeting by meeting basis, based on the incoming data.
We should stick to our meeting by meeting, analysis-based approach because the outlook is highly uncertain.
I would refrain from judging whether monetary policy is currently restrictive. The answer is not clear-cut.
ON GROWTH
When it comes to economic growth, all surveys early in the year suggested that the Iran war would have a devastating effect on economic growth. But despite elevated uncertainty and higher energy prices, this hasn’t happened. On the contrary, the second quarter was quite a good one, even exceptional, I would say.
Two items stand out: domestic demand has been strong, which comes from exceptionally good household consumption. This might change during a period of high energy prices and elevated uncertainty. The second factor was strong external demand.
Having looked at the composition of growth, it is a strong basis for future growth as services accounted for a large part of the good performance, increasing the chance it was not a one-off. PMI indicators also point to continued momentum.
ON YIELDS, SPREADS
There are a couple of external and domestic explanations for the rise in longer-term borrowing costs, which was in a way unexpected and warrants our attention. We have seen a strong credit cycle in the AI sector and this has an important crossover effect. We have also seen a rise in U.S. Treasury yields and financial markets are interconnected today more than ever, so there is a strong spillover effect.
But then we also have internal factors in Europe which might contribute to the increasing yields. Stronger economic growth could also be a factor in increasing interest rates while debt sustainability concerns are also an important factor. In this regard, governments are in the driving seat but this combination of high sovereign debt and yields needs to be monitored closely.
For now, monetary policy is transmitted more or less homogeneously into broader financial conditions all over the euro area. We haven’t seen any destructive effect of rising yields on other parts of the economy.
I would not comment on the fiscal position of any individual euro area member state. However, fiscal policy is an important element in the transmission of monetary policy, and we therefore follow these developments closely.
(Reporting by Balazs Koranyi)
