The Bank of Spain estimates that interest rates could continue to rise to 2.5%

Hernández de Cos warns that, the more persistent the inflationary phenomenon is, the probability of second-round effects increases

BILBAO, 29 Sep. (EUROPA PRESS) -

The governor of the Bank of Spain, Pablo Hernández de Cos, has pointed out that interest rates could continue to rise to 2.25% or 2.5% with current data, although he acknowledges that it is a forecast that may vary "with over time".

Hernández de Cos made these statements at the BEC in Barakaldo (Bizkaia) during his speech at the XXI Conference of CEDE Executives, which was attended by King Felipe VI.

In his speech, he indicated that inflation has become "a real determining factor" in economic developments at a global level and pointed out that the euro area, with an inflation rate of 9.1% in August, has reached a "historic maximum" in the Monetary Union. Likewise, he has underlined that the core inflation rate in the euro area has reached 4.3%, which is also an "all-time high" and "clearly a very high number by any measure".

Pablo Hernández de Cos has insisted that a significant part of this increase in core inflation, around a third, is due to the indirect effects of energy from food, but there is also a "genuine, independent" increase in these two parameters, and that is "a source of concern" for the European Central Bank.

In relation to the prospects ahead, he recalled that the European Central Bank published its latest macroeconomic forecasts at the beginning of September and for inflation in the euro area, it forecast an average level of inflation for this year slightly above 8%, by 8.1%, which would stand at 5.5% in 2023 and would drop to around 2.3% in 2024.

The governor of the Bank of Spain has also added that there are three "focuses of risk" in relation to the aforementioned forecast and the first has to do with the possible appearance of second-round effects, among others salary increases, which ends in a " inflationary spiral" and inflation a "more persistent" phenomenon.

Hernández de Cos has stated that the European Central Bank's inflation forecasts do not include "relevant" second-round effects for the euro area and has assured that "they are not occurring in a significant way", since, for example, the The evolution of wages is around 2.5% or 2.6%, "clearly below" the 9.1% inflation rate, which represents "a very important drop in real income for workers." In relation to the margins, he has also stressed that they are being "very moderate".

Therefore, he has assured that they are "reassuring elements", but, the "more persistent the inflationary phenomenon is" and this is being "very persistent", the "probability of these second-round effects occurring" increases.

On the other hand, he pointed out that there is also "the risk of a certain disembedding" of inflation expectations. He has indicated that, in this case, as in the case of second-round effects, the "signals are positive" and "elements of de-anchoring expectations" are not perceived.

"When one looks at the financial markets, they are effectively giving us expectations of inflation in the environment slightly above 2%. When one analyzes, not only the ECB's forecasts, but also those of many other institutions, the private sector, the medium-term forecasts they are also anchored in that environment of 2%", he added.

Another element of risk has to do with the economic evolution itself, which is "very conditioned" by geopolitical factors, which are "completely exogenous to a greater extent to the reaction of central banks and even citizens."

In this sense, he referred to the fact that the European Central Bank published an adverse scenario, with a greater persistence and severity of geopolitical tensions, which led to a "clearly more negative" macroeconomic evolution for the coming year, since, If in the central scenario growth of the euro area is forecast at 0.9%, in this alternative scenario a negative increase of 0.9% is expected.

The governor of the Bank of Spain has indicated that this more adverse scenario would affect medium-term inflation, which would also be higher, at 2.7% in 2024 compared to 2.3% in the central scenario. "These are the sources of risk, but they have not materialized," he indicated.

In relation to the strategy of the European Central Bank (ECB), he recalled that it has a "price stability mandate" and that it is defined as trying to achieve 2% inflation on a symmetrical basis.

As he explained, the ECB does not want today's inflation to be 2%, but rather that of the medium term "and 2024 can be taken as a good reference". In this sense, he has pointed out that in Europe we are essentially facing "disturbances of a supply nature" that generate "adverse effects" to economic growth, which is downward and with rising inflation.

"One can naturally think that the increase in inflation generates a drop in real income, both for businesses and workers, which, in some way, could end up reducing inflationary pressures in the medium term. Therefore, the reaction of the Central Bank has to be different in the face of a supply shock than in the face of a demand shock", he specified.

He has indicated that this has been the ECB's strategy and what has justified the fact that, practically at the end of last year, it decided to gradually reduce "the enormous degree of monetary expansion".

Pablo Hernández de Cos has indicated that the process of normalizing monetary policy will continue and interest rates will continue to rise. "The question is, one, at what speed and, second, to what extent", are the two big questions that the market and the citizens are asking themselves, "he added.

In relation to what is going to be the maximum interest rate that is going to be reached, he stated that the reality is that "nobody knows where that terminal interest rate is located" and it is not only due to uncertainty, but also to events futures.

However, he has indicated that this does not mean that the Central Bank cannot give "some indication in the future of where it can be located with the information that this type of terminal has today."

Hernández de Cos pointed out that the Bank of Spain experts have made forecasts based on a series of macroeconomic models and estimate, with current data, that the median value of the terminal rate in the different models is between 2.25 % and 2.5%, but has assured that it cannot be considered "at all" as a commitment by the ECB because it is "a forecast based on models conditioned on current information". He added that the spread is data dependent and "will change for sure over time", but it is "a valuable tool".

In this sense, he has pointed out that the speed depends fundamentally in the current context on the "extremely high uncertainty" that exists and, for this reason, the data will be analyzed, and it will be seen "meeting after meeting, without prior notice, on what is going to be the size of the next move in interest rates.

After indicating that the economic literature does not offer a very clear solution on how a central bank should act when the level of uncertainty is so high, he pointed out that there is a vision that points to being "very prudent" and moving "in a very slowly", but there is another that points out that, in a scenario of very high inflation, the ECB cannot allow a de-anchoring of expectations and has to anticipate and "be more aggressive".