The economic situation in the Euro-region is “very unusual”, however many reasons for optimism remain, said Philip Lane, the Chief Economist of the European Central Bank (ECB).
Lane’s comments came at a Reuters Newsmaker event in New York last Friday during a wide-ranging interview with Reuters Economics Editor Dan Burns. At the event, Lane described the ECB’s recent moves to try to boost the area’s economy and tossed cold water on the idea that there are serious divisions within the ECB’s board of governors.
Lane began by explaining the context around some of ECB’s recent actions. In December, he said, when the decision was made to end the ECB’s asset purchase program (APP), the 2021 inflation forecast was at 1.8%. It’s since moved to 1.5%. “When you have the inflation forecast going from 1.8 to 1.5 you can’t be indifferent to that,” Lane explained. “That’s a significant move.”
In response, the ECB cut its deposit rate by 10 basis points, to a record low of -0.50%. It also reinstated the APP and instituted a new tiering system meant to insulate banks from some of the implications of negative interest rates. Noting that there is good reason for economic optimism, Lane characterized the region’s labor market, services sector, household investment, and consumption as strong. The exception, he said, is manufacturing, resulting in “a very unusual asymmetric sector-specific slowdown.”
He said the ECB’s reaction was not “a dramatic policy move” but rather a recalibration, adding that the bank did not see a serious recession risk.
On another subject, Lane played down the idea that there are serious policy divisions among the ECB’s governing council. He did not mention Sabine Lautenschläger, a German member of the ECB’s executive board, who had criticized monetary easing and announced two days earlier that she would leave the ECB. “It’s always interesting and dramatic to focus on differences of view,” Lane said, noting that there was a “high consensus” that a monetary easing was required. He did allow that on individual elements of the package, there were differences, some of which are “sort of structural about the role of sovereign bond purchases in monetary policy.”
None of these disagreements bothered him, he said, nor did their sometimes-public airing. He said it’s “perfectly reasonable” to have differences and even for debates over those differences “to be reflected in the public discussion.” He added: “I think it’s fine.”
Weighing the risk of recession
Reuters’ Burns asked whether there is a risk that weakness in manufacturing could start to slip into the services sector, and if it was possible that perhaps Germany is already in a recession.
Lane admitted that, because Germany is a manufacturing “powerhouse,” the manufacturing slowdown is “disproportionately” impacting Germany. He said any spillover into services “will be stronger in Germany than elsewhere.” And while Lane agreed that there is downside risk, he reminded the audience of the positives. “Wages are growing at quite clip,” he said. “It’s a case where we need to reinforce this by this extra policy move rather than some diagnosis of some major serious limited recession. Individual countries may tip for a while, but not the overall area. We don’t see it.”
When asked if the ECB’s forecast of 1% growth might be too optimistic, Lane was quick to defend his staff. “I think the staff works hard to make sure they strike a balance between optimism and pessimism,” he said. “I’m impressed by how the staff go about their forecasting exercise.” He admitted that there were risks, such as that of a hard-Brexit, for example, and of escalating global trade disputes. “We can all have different views about how likely those scenarios are,” he added.
Lane said he does not think the basic mechanics of inflation have changed. The history of the Euro is that when unemployment falls to about 7%, raises are passed through to consumers, he explained, adding that wages are growing, but firms are absorbing those cost increases rather than raising prices.
If trade uncertainty and geopolitical uncertainty are lifted, he said, “the history of squeezed profit margins is that it doesn’t last forever,” and firms eventually have to raise prices. It is “uncharted territory,” he observed, to see unemployment come down so low without inflation, “but that’s not bad. It’s good. It just requires central banks to respond to that.”
“If this good news story about strong labor markets is inconsistent with the inflation target, that would be a failure by the central banking community.”
Lane was also asked if the ECB might soon undertake a framework review, as the U.S. Federal Reserve is now doing. He said no decision has been made, but seemed to be in favor of the idea. “I think it would be good timing,” he said. “It’s been 16 years since the ECB did a strategy review.” The last framework review, he said, was in 2003. In 2008, when the organization would have been due for anther review, the ECB was instead dealing with the global financial crisis.
Now, he said, not only is a review possibly overdue, but it makes sense given that the leadership of the ECB will soon change (Christine Lagarde will become the president of the ECB on November 1). “And it makes sense to also learn a lot from what the Fed is doing,” he added.