«The rate reduction that has just started will continue in the coming months, but gradually. The ECB rightly fears the risk that inflation will show signs of recovery, as in the United States. In that case the Bank should immediately reverse course and not only stop cutting rates but even increase them again, which would make it lose credibility.” Lorenzo Bini Smaghi, economist and banker, former member of the board of Eurotowerhe is however convinced that the downward trend must not stop, yet he believes “it is understandable that there is caution at this stage”.
What is the most likely scenario at this point?
«As Christine Lagarde said, monetary policy remains restrictive, but forecasts for the coming months indicate that we are now quite close to reaching the 2% target. Furthermore, the ECB has indicated that wages are slowing, so inflationary pressures are expected to decrease in the coming months. The Central Bank would therefore be making a mistake if it did not continue to reduce rates. Waiting for more data is correct, but waiting too long could lead to excessive restriction.”
How many further reductions should there be between now and the end of the year, assuming that the slow glide of inflation continues as the consensus of economists says?
«A second cut could take place in September, when the next forecasts will be available, and a third in December, if the data confirm the forecasts of continued reduction in inflation. A faster cut could only happen if the European economy disappoints recovery expectations.”
In the meantime, we need to monitor the Fed: in America inflation is even higher because the economy is stronger: 3.4% in April versus 2.4% in the Eurozone (but with a preliminary Eurostat figure of 2.6 in May). How should the US central bank behave?
«The American economy is supported by a fiscal policy, i.e. public budget, which continues to be much more expansive than in Europe, as well as by a more sustained productivity dynamic than in our continent. All this creates inflationary pressures that require high rates for a longer period.”
But now there are signs from the labor market of greater moderation, both in hiring and wages, and the Fed also has the mission of protecting employment.
«The official data on the labor market arrives on Friday (today, ed.) and we will see what they say. Many options are open: according to some economists, the Fed’s next move could even be a hike, perhaps after the elections. In fact, the programs of the two presidential candidates are both expansionary, which will require higher rates, in the short and long term.”
Still speaking of employment, what do you comment on the ongoing debate on the opportunity to also give the ECB this second mission?
«The treaty establishing the ECB already establishes that “without prejudice” to the objective of price stability, the Bank must support the general economic policies of the Union, as a secondary objective. The problem is that the formulation adopted is a little too generic, and everything can be included, from growth to employment to market integration, up to the climate transition, all items which in some cases may be in contradiction between of them. However, the ECB does not have the democratic legitimacy to choose which of these sub-objectives to give more importance to. It should be the European institutions, including the Council and Parliament, who clarify this point to facilitate Frankfurt’s task. And there is no need to change the treaties to do so.”
