(Bloomberg) -- The European Central Bank has room to lower borrowing costs further as inflation approaches its target but must pay close attention to upside risks, according to Governing Council member Christodoulos Patsalides.
While the 20-nation euro economy is undoubtedly slowing and may prove weaker than the most recent forecasts indicate, the same can’t be said about price pressures, said Patsalides, who also heads the Cypriot central bank. Policymakers should therefore tread carefully and avoid removing restriction too soon.
“If there are no upside surprises to inflation, then we could and should continue lowering our interest rates,” he said in an interview in Washington, where he’s attending the annual meetings of the International Monetary Fund. “December is an important month because a lot more data will be available, including new projections. So, we will be in a better position to assess our stance.”
His words of caution come less than a week after the ECB sped up its pace of interest-rate cuts and President Christine Lagarde fed expectations among economists and traders that another move is likely at the Governing Council’s next policy meeting. In an interview with Bloomberg TV on Tuesday, she said it’s clear that borrowing costs will come down further, even if it’s not yet clear at which pace.
Patsalides argued in favor of gradual steps — as opposed to “serious cuts” — to avoid feeding volatility and uncertainty. Moving in half-point steps would only be justified “if the situation deteriorates significantly,” he said.
Such an outcome isn’t currently in the cards, despite some disappointing surveys pointing to weaker activity. The ECB still clings to expectations that private spending will pick up as inflation retreats, wages rise and the labor market holds. Exports are seen picking up as well.
“The euro-area economy is slowing, but it’s still heading for a soft landing,” he said. “But, of course, there are risks such as geopolitical shocks. The global environment is becoming riskier and less predictable.”
Trade wars are a particular concern since they damp growth and bolster inflation — and may thus bring stagflationary forces to the euro zone, he added.
“Risks to growth are clearly to the downside,” Patsalides said. “But it’s not as clear that the inflationary path is tilted in the same direction, also because of potential supply shocks, oil prices and trade wars. Risks to inflation are more or less balanced and we shouldn’t ignore the upside risks.”
His views differ from those expressed last week by Lagarde. She too identified upside and downside risks, though argued there are “a bit more” of the latter.
Other Governing Council members are already warning that the ECB is at risk of undershooting its target once again. Finland’s Olli Rehn and France’s Francois Villeroy de Galhau were among those urging colleagues to be mindful of such a scenario.
“I don’t necessarily think that at the moment the risk of undershooting our target is bigger than the one of overshooting it,” said Patsalides. “There are equal risks on both sides.”
That’s why right now a restrictive stance is still needed, he added.
“If we were absolutely convinced” that inflation will reach 2% sooner than forecast last month, “we would rethink our monetary policy path,” he said. “But we still don’t have the data to firmly draw that conclusion.”
The battle against inflation is “not yet won.”
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