Transcript of Governor Gabriel Makhlouf's interview with Martin Arnold, Financial Times

15 February 2022 Interview

Gabriel Makhlouf

Interview with Governor Makhlouf conducted 10 February 2022

Martin Arnold: So, as you know, inflation is at a record high in the Eurozone, 5.1% in January. So, I'd like to start by asking you what worries you the most. Is it the risk of the ECB being too slow to respond and finding it has to slam on the breaks to stop inflation spiraling upwards later on? Or the danger of the ECB repeating the mistake it made the last time it raised rates in 2011, of tightening prematurely?

Gabriel Makhlouf: Well, let me sort of answer it in a couple of ways perhaps, let me just talk about where we are. As you say, inflation is high and it’s been increasing since last year for a variety of reasons as we know, higher energy prices. What we’re seeing coming out, the recovery out of the restrictions, a recovery in the price of goods and services that fell sharply during the pandemic. The rebound in demand and the supply side bottlenecks which are then packed in behind. There's been a lot of narrative about that. And but I mean we still see; we sort of expect inflation to decline in the course of the year. But it is going, it’s likely to remain higher for longer than we'd previously expected. And I suppose my first answer to your question is, why are we concerned? We’re actually concerned because it’s affecting people’s lives and I think that is… and I think the President mentioned that in her press conference last week. I mean we are not blind to the impact it’s having on households and businesses around the euro area. So, quite naturally we’re concerned. I mean perhaps one of the things that has changed between the meeting in December and where we are now is that we’re beginning to see price changes becoming more broad-based to beyond just energy prices. Core inflation has gone up reflecting the slow pass through of the indirect energy price increases as well as the supply bottlenecks. And we've got to keep very close attention to developments at core inflation to help us form a view on what inflation dynamics over the medium-term, what's happening to them. And that’s, I mean I think sometimes in a lot of noise in stuff about what's happening right now, people forget that I mean that part of our focus or I think part of our focus, is what's happening to inflation over the medium-term. And I think, and I've said this before...we live in pretty uncertain times. You could say well that’s something that you know, you guys always say we live in uncertain times, but as I flagged before, we haven't had a pandemic like this one. We haven't had economies close down in the way that they have, that they’ve all closed down. And now that we've never had the economies coming out of this pandemic. So, it is particularly uncertain and I think my watch words have been vigilance, flexibility and optionality in the conduct of monetary policy. And for me, they're the things that are most important. We need to continue to be forward-looking as a Governing Council over the coming months in our analysis, in our assessment. While recognising the extent of uncertainties that exist right now. We've got to be, and this is a phrase you'll have heard from others, data driven.

Which I'm absolutely committed, I'm a believer in. But I'm more than just the believer in being data driven, I'm also a believer in listening to businesses and non-financial corporates telling us their stories. So, for me, I'll try and gather the richest possible amount of data if I can put it like that. The richest possible amount of information to help me come to a judgement. And you mentioned 2011, and whether we are worried about what you described as the mistakes of 2011. I mean it’s a very interesting question. I mean actually, one of the things I checked was how many of the Governing Council were there in 2011 and I think only one of us was there back in 2011. The most important and perhaps the most difficult part of monetary policy is setting it at precisely the right level at precisely the right time. And what happened in 2011, now as I said I wasn't there, so this is partly me and history. What happened in 2011, that rates were raised on the assumption that increases in energy prices were feeding or were about to feed into more broad-based pressures. But in the end, it turned out that wasn't the case. Headline inflation reduced in response to the energy price reversal. And as we know, remained well below target and it’s one reason that energy price shocks tend to be why you know, consensus is that monetary policy should look through them. So, there are similarities between where we are today and 2011, but there are also differences. And we need to make sure that our assessment is pulling the current high headline numbers into a broader context. So, the sorts of questions I think we need to be asking ourselves is to what extent is the economic recovery and the convergence of inflation to our medium-term objectives, self-sustained. To what extent are those two things dependent on the current degree of monetary and fiscal accommodation. How likely is a sudden reversal in the pressures we’re seeing in the energy markets and how would headline inflation respond to that? So, there's all sorts of things we need to think about. But well, that’s my long answer to your slightly long question Martin.

Martin Arnold: You talked about a few specific parts of pieces of data, including core inflation. Christine Lagarde said in last weeks’ press conference, ‘The situation has changed’. So, what is it about the data, about inflation or otherwise that has changed, that has led to this growing concern in the ECB about where we are?

Gabriel Makhlouf: I mean I think you know, from where we were in December, we've had a few more weeks that have passed, that actually our most recently meeting was slightly later than the usual period we have between our December and our first meeting of the year. So, we had the flash estimate just for one as an example. And I think what we’re seeing is a picture that’s slightly more enduring. Well, it’s posing questions for us. I mean I mentioned some of them just then. It’s posing a few more data points, just posed some of those questions perhaps a bit more forcefully. Obviously, we’re looking at the global picture and trying to understand what's happening there. In our own individual countries, we’ve, certainly in Ireland’s case you know, I think actually Ireland was one of the countries whose flash estimate was lower for January. It was lower than December. But we forecasting inflation, the Central Bank of Ireland, forecasting inflation for this year to be above the 2% target. I mean 4.5% was our last estimate. But we are again forecasting it to fall over the forecast horizon so…

Martin Arnold: But then, so 4.5% would be up on 2021, wouldn’t it? It was 4.5% in the whole year.

Gabriel Makhlouf: Yeah,’s elevated, absolutely, for the reasons that we know. And certainly, the Irish economy is recovering pretty well from the pandemic and the coming out of the restrictions. I mean at a macro level, certainly sectoral, hospitality and service-based industries, face-to-face industries and businesses…it’s hit them much harder. One of the factors is…different council members will have slightly different views. One of the things that’s particularly interesting is what I'm seeing in the labour market and what I'm seeing in Ireland and what I'm seeing in the euro area. Unemployment is at its lowest level. Like we’re not seeing this feed into wage increases. You know, the sorts of second-round effects the monetary policy makers worry about. But some of our data on that always comes with a lag. But you know, the labour market looks in pretty good shape. And certainly, in Ireland it’s in pretty good shape and in the euro area it’s clearly improving. As I said, the wage growth remained subdued last year and hopefully over the coming months we’re going to have better data to get a better sense of where things are. Personally, I think the development in the labour market would be central to our deliberations. Certainly, to my own thinking and my own views, we’re going to have to track the extent to which the cost-of-living pressures are reflected in wage demands which will obviously put more upward pressure on firms costs and prices. I mean the last set of negotiated wage agreements that I've seen, which are up to sort of Q3 last year, appear to be in line with our 2% inflation aim with an additional uplift of about 1% productivity growth. But let’s see what happens during the course of this year.

Martin Arnold: Are you seeing any signs of wage growth picking up, accelerating? I mean there was a little bit in the survey that the ECB did of businesses that came out, I think the day after last weeks’ meeting.

Gabriel Makhlouf: Yeah, I mean we’re getting evidence from those sorts of sources. And certainly, when I talk to some of the non-financial corporates that I've spoken to, businesses based in Ireland, not multinationals you know, one of the top subjects that comes up every time is the sort of dearth of talent and the tightness of the labour market raw talent. And there's a bit of discussion about wage pressures, but not to an extent that I would say you know, I've now got strong evidence of things moving. On the other hand, I would not be surprised if that evidence does start to emerge as unemployment is at such low levels. And we are projecting unemployment to fall further from the record low. So, the tightness of the wage growth relationship and how we’re able to demand what we…is going to be pretty important for us.

Martin Arnold: That’s, I mean that’s really interesting. The emphasis market…as you’ve said, I've heard others talk about it and how crucial it is and whether there is an acceleration in wage growth and signs that second that effect is going to be crucial to the determination of the ECB policy. But we've got less than four weeks now before the March meeting, there's expectations in the market that the ECB is going to shift policy based on you know, concern about inflation. But there still don't seem to be any real signs of actual second round effects. So, if there aren't any of those still when you meet in March, does that mean that you won't change policy or do you just assume it’s going to happen because logically the cost of living’s gone up therefore wages must go up at some point and so, let’s tighten policy in anticipation? Or do you want to see the whites of their eyes?

Gabriel Makhlouf: Well, I certainly want to see you know, fresher evidence and more evidence. But okay, let me… I'll answer your question specifically, but let me just sort of go back into another labour market a little bit more so you have a sense of why it may take a little bit longer to come to a reasoned view. I mean labour demand can be met from unemployed workers, it can be met from increased labour force participation and even increases in the labour force itself via migration. So, we've got to look at all of these. If you look at Ireland, before the pandemic population projects had over two thirds of growth in the working age population coming from net inward migration. And I think Germany and Spain similarly rely on inward migration to grow the labour force. Now the pandemic disrupted this pattern and we’re seeing labour markets adjust. And suddenly, in Ireland we see labour force participation in the sort of under 25 age group increase sharply, particularly for women. And participation in the euro area has held up strongly, I think it’s returned to levels more or less in line with pre-pandemic…which is incidentally different to what's happening in the US.

Are we not going to change policy in March because we haven't got enough new information? I mean my view and you know; our March meeting is not that far away. We all have some more information, at the very least we’re going to have a staffs forecast to look at. But what I expect, I mean my sense right now is that the path to normalisation has become a little clearer. Not clear, but clearer. I certainly think there's a bit of a difference between the calendar we’re working to and the one that some market participants may have in mind. The position we’ll be in in March I think would just you know, help with the clarity. I keep emphasising, I don't expect things to be clear, just clearer from where they were. But I think we are, we can see the you know, compared to where we were say last October, the path to normalisation is a bit clearer. I think an important point that I keep emphasising when I chat to people about this is that we are running, and have for a while, a very accommodative monetary policy. And the debate that we’re really having is how much more accommodation is needed, should be maintained, how much, you know. And a lot of the talk in media and markets and whatever is you know, about us tightening. I see it less as tightening and more as reducing accommodation. And what's the path to reducing that accommodation. And what's the pace at which we’re going to go along that path. I mean the reality is that because of the uncertainty, we want to move in a very informed way because, accepting that inflation at the levels we have now are impacting on households and businesses in ways they don't want and no one wants. We also don't want to kill off the recovery. So, we've got to find the sort of calibration. But we do have the tools at which to exercise optionality, exercise flexibility and to maintain our vigilance to make sure that in the medium-term, inflation does get to our 2% target.

Martin Arnold: Can I talk to you about the bond market reaction. I mean I was just looking at a chart of Irish ten-year bond deals and you know; the country’s borrowing cost has gone from just over zero in December to 0.75% in the last day. And other countries borrowing costs have gone up even more, like Italy and Greece. Is this a concern? Do you think the market has over-reacted to what the ECB has signalled so far? You haven't actually done anything, you just signalled you might be prepared to do something. And at what point does the ECB get worried about this, so worried that it actually has to intervene to try and correct the widening of these spreads?

Gabriel Makhlouf: As I said a few minutes ago, I mean I do think that some market participants are operating on a slightly different calendar to the one we’re operating on. As you know, I mean certainly from the beginning of the pandemic, ensuring favourable financing conditions has been pretty central to restoring inflation momentum. And guiding the formation of inflation expectations. Although there's been a sort of, as you say a movement in…and real yields following our meeting. Real yields do still remain at exceptionally low levels and if you just… well, if you only looked at that metric you'd say that financing conditions remain favourable. But for me, the most important thing actually is less the spreads for sovereigns and corporates, but actually the functioning of the market. And clearly market pricing has always been and will remain highly reactive to data. Before I answer your question specifically on when should the ECB or how should the ECB react, I just want to emphasise that point I was making that the functioning of the market it something itself that should be focussed on. We, and at the moment view is that the spreads had a limited impact on market functioning. Bank lending rates, firms and households incidentally, I mean they're also at historically low levels. So, overall, taking market-based, bank-based funding costs, I think financing conditions overall remain favourable. I mean the issue for me, sorry for the ECB but also for me, when should we you know, intervene if you could put it like… I can't remember what word you used exactly. I mean essentially, when the transition of, the transmission of monetary policy is put at risk, I mean that’s really at the end of the day the most important thing for us. You know, that’s when we need to react. I mean the single monetary policy in the euro area is you know, fundamental to ensuring the proper functioning of the transmission mechanism. We've got all the tools at our disposal to deal with that. And obviously, spreads are important indicators and would be monitored sort of carefully. And as I say, I don't think it’s just the spread level, it’s how the market is functioning that’s important. We announced the decision to end the purchases of the PEP last December and we said that if there was a threat to price stability mandate through fragmentation, we can use PEP reinvestments in a flexible way across time, asset classes, and jurisdictions at any time. So, if we saw a threat to the transmission of monetary policy we would react in the appropriate way.

Martin Arnold: You could also restart PEP

Gabriel Makhlouf: Well, we could. I'm not sure that at the moment on the menu of things that we would be doing, that’s something that sort of pretty high on the list. But you're right. I mean we've got the flexibility and the option.

Martin Arnold: It was specifically mentioned in December, I mean in your statement.

Gabriel Makhlouf: Indeed. But I'm just saying, at the moment as I said a few minutes ago, in a world where we’re seeing this sort of slightly clearer path to normalisation, reintroducing PEP as a sort of top of the list of things that we would jump to. But it’s an option absolutely, and, at the end of the day the transmission of monetary policy is what we’re about and we will use the tools that we have to make sure that it works.

Martin Arnold: One of your colleagues on the Governing Council, I'm not going to mention names, but has suggested you could raise interest rates before you stop net asset purchases. The so-called sequencing question. What are your thoughts on that? Most of your colleagues seem to think you need to stick to the sequence of stopping net asset purchases before you get on to raising rates. Is that how you see it?

Gabriel Makhlouf: Yeah, it is how I see it. I mean you used the right sort of word a few minutes ago. We could, we could raise rates before we end asset purchases but I don't think… frankly, I don't think anyone’s seriously in that space. Certainly, my sense of the last discussion that we had is that the sequencing that we've already flagged is the sequencing that we’re all pretty committed to. So, we’re going to be focussed on asset purchases before we’re focussed on interest rates in that order. Which is what I, to be honest, which is why I said what I said a few minutes back which is that the calendar that some market participants are sort of operating to is different to ours because…if you take our… I hope people do take our commitment to sequencing seriously. If you take that, then the notion as some of the markets have indicated you know, there'll be a rate hike in July, just seems to run pretty counter to everything we've been saying.

Martin Arnold, The Financial Times: I mean June is the earliest, 80% chance of a rate, a ten-basis point hike in June at the moment is…

Gabriel Makhlouf: Well, the other word that I would flag now, which I know the President used, is the word gradual. So, if you think, if you say to yourself well you know, the ECB is signalling and has signalled most recently. But it'll move in a gradual way. If you then add to that that it has already indicated a sequence in which it will move. The idea that there'll be a hike in June looks very unrealistic to me. Now you know, events, events dear boy, events may you now, may turn out differently. But sitting here today talking to you on the 9th February, it’s very unrealistic.

Martin Arnold: I mean how much notice do you have to give before ending net asset purchases do you think? You know, in March could you say right, in three months’ time net asset purchases will have ended? And is it important to put an end date on those?

Gabriel Makhlouf: I think it’s important to signal to the market. Well, to signal to everybody frankly as to what we’re doing, what we’re seeing and therefore what we’re doing. I think gradual change is much, much better than abrupt change. If you have a crisis then obviously things are different and I was reflecting before we spoke at the discussions we were having on March 12th 2020 and what then happened on March 18th 2020. But we’re not in that world. So, in a nutshell, I think it is important to signal both what you're thinking, what you're seeing and what you're planning to do. I mean at the end of the day you're going to be driven by the evidence and data. And will we announce, could we announce in March that we’ll end asset purchases in June? I mean that’s an option. I think that’s probably, I mean I would you know, I'm talking personally now, I'm not talking about my colleagues. Personally, I'd like that sort of view to be supported by the evidence. But if your question was how confident am I that asset purchases will end this year; I'd say I'm reasonably confident asset purchases will end this year. And the question is, what's the pace at which my foot sits on the accelerator if I could put it like that. And you know, am I talking about June, am I talking about you know, Q3? But that’s for more consideration and careful, kind of deliberation over the coming weeks.

Martin Arnold: The critics would say if you are convinced that inflation is going to be at or above your target over the medium-term, then why would you carry on buying assets for the next three to six months? You're just adding fuel to the fire.

Gabriel Makhlouf: And I think that critique is a reasonable one. And I think from my perspective, how much of a surprise would that be to the markets? And if it was a surprise to them, how well could we explain it to them, that sort of judgement that we’re making. So, I mean I understand the reason for the critique. I mean I think, to be honest I think the sort of crucial issue for us when you look at our forward guidance, is going to come to the judgement on whether what we’re seeing is durable. It’s that word, durable, which you know, which right now is… pretty significant question because the models are going to come out with their numbers right. And I personally am not somebody who is… I mean the models belong to staff, they do the forecasts, I'm in many ways more interested in the inputs into the models as the outputs. That will inform us, but the question I think which will require judgement as opposed to modelling, is the one around durability. And we've got a… you know, if we can persuade ourselves one way or another, we need to be able to explain that. And help everyone understand what we’re seeing and why we’re doing what we’re doing.

Martin Arnold: What effect does the tension in Ukraine have in your deliberations and in your judgement on this? Because clearly, it could have a major effect on energy prices this year and possibly further in the future depending on what happens. And obviously, nobody knows what's going to happen but how do you incorporate that into your judgement?

Gabriel Makhlouf: Well, I think the short answer to your question Martin is, with great difficulty because if I knew what was going to happen, then obviously I'm probably in the wrong job. And not only… I mean it’s obviously a very, a big geopolitical issue and carries significant risk for, not only for energy prices to be honest. For the European economy, potentially the global economy. We can't, I can't, I can't make you know, decisions based on what I think will happen in the Ukraine. I need to make decisions on what I have reasonable confidence in, based on the data that I see and on the evidence that I gather from talking to businesses. But the way the Ukraine could play out, there's all sorts of variable are possible there. And it would be better for everybody I suppose if we didn’t have that variable in front of us as we're making our judgement. But it’s just one of these risks…we said at the Governing Council that risks to inflation are all on the upside. And that’s a particular factor that sort of helps to make that even worse if I can put it like that.

Martin Arnold: Okay, I'm going to go back to the question I asked at the outset. So, what worries you more, inflation massively overshooting for several years to come and you being too slow, being behind the curve. Or you slam on the breaks now and then everything slows down and inflation falls well below target again and we’re back to the pre-pandemic world of you know, inflation being too low and it looks like you’ve made another premature tightening, a mistake. What worried you more at this stage? It sounds like you're more worried about the former than the latter, is that right?

Gabriel Makhlouf: I think that, I mean you’ve put it in a wonderfully binary way Martin, which of course in the real world I rarely have binary options put in front of me and not permutations of these. But if you think of the world that we have come from, now I'm talking about the world pre-pandemic, I do… well, there's two points here.

One, the world that we come from and the medium-term, the world that we’re moving to in the medium term, which we haven't really talked about. The world that we came from was one where we had a relatively slow-moving European economy, inflation you know, below target and so on. We’re now in this sort of pandemic/post-pandemic world which is more uncertain than usual. And in the medium-term, we we’re moving into a world where there's potential structural change emerging, some of which we know about and have a sense of what it might be like and some of which we’re not that… we sort of know about, we’re not clear what it'll mean. And that’s a mixture of the transition to net zero, the whole demography issue, the impact of the sort of increased digitalisation is going to have on the way our economies work et cetera. I mean some of those structural changes require careful analysis and consideration. So, in that context, moving from where we are, sorry from where we've been, I am probably… in your binary world, I'm probably more worried about making decisions too quickly that take us back to that sort of closed down economies if I can put it in a very, slightly pejorative way than I am about taking action a bit you know, which see inflation…

Now we said in our strategy review that we could live with transitory you know, increases in inflation that’s above, average rate is above target. And I suppose on balance, again I emphasise answering your binary question, I'm more wary about reacting to what I'm seeing now which by and large are sort of an exceptional set of either supply side pressures or the emergence from the pandemic and cleaning off demand at an aggregate level than I am about making sure we don't have an overshoot. At the moment, I think if we have an overshoot, the commitment to the Governing Council who are price stability target I think is very, very strong. And if we’re going to have an overshoot it'll… I mean we’re not aiming for overshoots but if we’re going to have one, it'll be… I would envisage that it is a temporary and transitional one. But that’s, I mean I'm talking today in terms of what I know and we haven't talked about this, but I know some are comparing our action taking or not with what the FED is doing. I think we are in different circumstances to what the FED is, where the FED is. So, in a months’ time I may have a different view. But right now, what the evidence is telling me and I emphasise today, is to exercise in your binary world, chair about reacting too soon. On the other hand, as I also said, I think the path to normalisation has got a little clearer. I anticipate it will get clearer over the coming months. That ultimately will determine our decision-making, or mine anyway.