MNI INTERVIEW: Risk Rising Of Sub-2% ECB Rates-Malta's Demarco

Uncertainty surrounding international trade increases the risk of lower growth and well-below target inflation over the medium term which could justify European Central Bank rates below 2%, Bank of Malta acting Governor Alexander Demarco told MNI.

“If headline inflation in the medium term is expected to remain persistently well below 2% then it is more likely that there is room for interest rates to fall below 2%,” he said in an interview, stressing that this would also depend on medium-term inflation expectations remaining well-anchored and on other key indicators “behaving in a manner conducive to the attainment of our price stability objective.”

Uncertainty has become the new norm and increases the risk of negative confidence effects for investors and consumers that are damaging to economic growth and threaten to lower inflation, he said, pointing to U.S. President Donald Trump’s on-again, off-again tariff threats against Europe.

“Such a situation reinforces the appropriateness of the stand that has been taken by the Governing Council in recent months to continue to act with a steady hand but with great caution as we navigate through thick fog,” he said. (See MNI SOURCES: Risks Tilt To Downside As ECB Mulls Path Below 2%)

ALTERNATIVE SCENARIOS

There has been a growing consensus within the Governing Council that baseline projections represent just one possible outcome based on the information at the cut-off date, and June’s projections will include alternative scenarios for trade including and excluding retaliation by the European Union.

“Assessing which scenario is more likely to materialise has become the name of the game currently, and developments over the past couple of months have shown that it is no easy task to assign such probabilities,” Demarco said.

Still, projections remain very useful, he said, adding that while scenario analysis surrounding baselines has existed for many years it “has become increasingly crucial.”

“The baseline projection will always remain the central scenario for the given set of information available until the cut-off date. However, with consistent elevated uncertainty, various scenarios are needed to assess how key variables, like inflation and economic growth, behave under different assumptions,” he said, adding that the situation is similar to that of the pandemic outbreak in early 2020.

“I completely disagree with the view that the June projections are almost useless,” he said.

The projections will also contain a more benign scenario, though Demarco is sceptical over the chances of any rebound in confidence following a trade agreement with the U.S. or from peace in Ukraine or the Middle East. (See MNI: EU Countries See US Shift In Tone But Trade Deal Unlikely)

ASSYMETRIC EFFECTS

“Very often confidence does not operate in a symmetric fashion. While sudden and severe shocks could lead to a sudden loss in confidence with rapid adverse effects, the reversal is usually not immediate and takes more time until investors and consumers are reassured that the corner has been turned,” he said.

“Confidence effects are likely to precede and be stronger than the actual impact of the tariffs themselves, but likely to take longer to recover.”

But these lasting consequences are unlikely to include the loss of the U.S. dollar’s status as the prime global reserve currency, according to Demarco, who thinks that recent market movements are the result not so much of a loss of confidence in the currency and more of portfolio rebalancing following a reappraisal of risks.

“There is no doubt that financial stability risks have increased, and in the event of serious policy mistakes from the U.S. administration, this could lead to more adverse repercussions to the U.S. dollar,” he said, adding that even if the euro could benefit from this rebalancing, the chances of its becoming a global reserve currency depend more on the completion of reforms such as the EU’s Savings and Investments Union project and Banking Union, as well as on achieving greater autonomy in payments systems with the digital euro.