Governor Vujčić for Reuters

Published: 10/2/2023
Governor Vujčić for Reuters

The following is the text of a Reuters interview with European Central Bank Governing Council member and Croatian central bank Governor Boris Vujčić.

Q: There has been some anecdotal evidence that Croatia’s euro zone accession generated one-off inflation when businesses adjusted up their prices. What is your experience?

A: This did indeed happen, but I would not consider it a problem. Our experience is not different compared to other countries when they introduced the euro. The inflation flash estimate and our inflation nowcasting data confirm that yes, there was some impact of the euro’s introduction on prices, particularly in services. But this was as expected and was not large, probably around 0.3 to 0.4 percentage points, one-off effect. This is very much in line with the findings in all other countries that have introduced the euro.

Q: What’s your assessment of the ECB’s last policy decision and the market reaction?

A: I think the message from the meeting was quite clear: We will raise rates by another 50 basis points in March, barring some unexpected data surprises. After that, we’ll be looking at the data that come in the following months and decide on the interest rate moves then. The decision is not really different from what we said in December. The market's reaction is the market reaction. I don't think we should pay too much attention to how markets react in the immediate follow up. The credit channel is a more important transmission channel to our goal, and we should watch how that transmission works.

Q: Should we expect more rate hikes after March, like many of your colleagues say?

A: Given where we are today, I would agree that we are likely to see more rate action beyond March. But we're going to wait for the data to come in and then decide in May, June, July what we’re going to do.

Q: The market is pricing a 3.4%-3.5% terminal rate. Is that a reasonable expectation?

A: It’s the market’s job to try to figure out what the terminal rate is, but it’s not something we have to do at this point in time. We’ll wait for the data and assess accordingly. So, let me just reiterate, from where we are now, given recent data and our projections, we are likely to see more rate action beyond March and I would leave the issue of the terminal rate for later.

Q: Should rate hikes end by the summer?

A: I don't think we should put a calendar on it. Typically, of course, when you're in the rate hike cycle, you hike for some time, might pause, or not, then might continue, depending on the data. Then typically you would keep the rate there for some time until you are confident that the inflation is back to where you want it to be.

Q: If you say keep the rate there for “some time,” then is the market misreading the ECB when it prices a cut in early 2024?

A: I wouldn't even want to talk about rate cuts while we’re still in the process of hiking.

Q: Are you focusing more on headline or core inflation?

A: We need to look at both numbers. Monetary policy is clearly better suited to deal with core inflation as core inflation is mostly driven by demand side shocks. Core inflation provides a clearer picture of the underlying inflation pressures and thus could serve as a guide to where headline inflation itself is heading, provided that the economy is not hit by multiple shocks that can blur the relationship between core and headline inflation. In addition, when headline inflation has an important transitory component, a focus on core measures can help avoid monetary policy mistakes. However, headline and core are not independent of each other, and stable headline inflation is the ultimate goal of monetary policy as households care about the prices of all the items they buy. It clearly does not make sense to pretend that people do not eat or drive.

Q: What do you need to see in core inflation to be confident that policy is working and you're going in the right direction?

A: We need to see a sustained decline in core inflation. Core inflation is still clearly too high.

Q: When do you think that might happen?

A: HICP flash estimate for January 2023 that indicates lower inflation pressures than expected, stronger euro and new futures for energy, commodities and food indicate that there could be a downward revision of headline inflation forecasts in the new projection that will be published in March. However, we have to keep in mind that errors in the conditioning assumptions, mostly based on futures, particularly for energy prices, explain about three-quarters of the recent Eurosystem and ECB staff projection errors for inflation. In addition to their direct impact on consumer prices for energy, these assumption errors have also had indirect effects on the projections for non-energy inflation, so we can only hope that new assumptions will not come with large margins of error.

China’s reopening is a risk. But we also have lots of large, very energy intensive firms that have cut or shut production because energy prices were above their breakeven levels. Now prices are sharply lower, so you might see them reopen and that, in a way, and to an extent, might also work as an automatic stabilizer of prices. One fertilizer company in Croatia – Petrokemija – accounts for 25% of total gas consumption in a country. They are now shut down but they might be restarting production with lower prices of gas.

Q: Given this uncertainty, do you focus more on actual data than projections?

A: In times of larger uncertainty, you rely less on the projections, particularly on numbers further out.

Q: Has headline inflation peaked?

A: I believe so, already in November I argued that my worry was not a further increase in inflation, but the persistence.

Q: Disinflation is going to be rapid but what about the last mile, going from 3% to 2%? Is that going to be the most difficult?

A: In general, that "last mile" could be difficult if developments of headline inflation are dominantly driven by core inflation which is usually sluggish, especially in the environment of rising wage pressures. In this case monetary policy has to be restrictive enough to push the core inflation downwards, which is not an easy task as it could imply relatively high sacrifice ratio. On the other hand, there is a possibility that headline inflation will fall to 2% much sooner than expected due to various factors that operate from the supply side that could quickly feed into non-core related components and bring the headline figure down sharply, below core inflation. In this case, the task for monetary policy makers would also be difficult, but in a different sense. We would have to explain to public why we are keeping restrictive monetary policy stance if headline inflation already fell.

However, the whole disinflation process may also be more and less challenging at the same time because we now seem to be in a better position than we were two or three months ago. Conditions for a soft landing are clearly better. The economy proved more resilient, the winter is mild, energy prices are down, and supply bottlenecks have eased. Consumer confidence stayed quite robust, and the services sector held up well on the economy’s reopening and robust demand for leisure services.

Q: Is fiscal policy becoming counterproductive by being too loose?

A: Given the fact that most of the measures that led to an increase of government expenditures are temporary and that economic activity is more robust than expected I wouldn't say that we have to be very concerned at this point. However, if the rise of expenditures persists, additionally supported by demands for increases in public wages, this could drive up medium-term inflationary pressures, which would make it harder for the monetary policy to bring the inflation back to the target and could lead to re-calibration of monetary policy stance. Overall, government support measures to shield the economy from the impact of high energy prices should be temporary, targeted and tailored to preserving incentives to consume less energy, while more permanent fiscal measures should be aimed at boosting euro area's potential growth and productivity which would be beneficial for the mid-term and long-term inflation outlook.

Q: Wage pressures are clearly rising now. How concerned are you?

A: Wages are still just catching up. We had a real wage decline in 2022, and 2023 wage negotiations point to a nominal wage growth of approximately 5%, which is still below projected inflation.

We see increasing pressures on the wage front, but, for now, I would characterize it more as a price-wage impact, where the inflation is pushing up wages. So, the first leg of inflation fuelling wages is obvious. But the second leg, where wage hikes then fuel back into the inflation, has probably only had limited impact on inflation so far, and we still need to see the extent of that pass-through in the coming period, and the risk it presents to the persistence of the core.

Q: Markets have taken the announcement of quantitative tightening in stride. Does that raise hope for you that the balance sheet run off will be smooth?

A: From the start my feeling was that it will be a smooth process. We started carefully with smaller volumes, which will then be increased. The market has the capacity to absorb the numbers we’re talking about.

Q: That means you’re also keen to increase QT volumes?

A: Over time, yes.