Vitor Contstancio is a central banker through and through, a Portuguese economist who was Vice Chair of the European Central Bank and a former Governor of the Banco de Portugal, the nation’s central bank, who also held many top government posts including finance minister and Secretary of State for Budget and Planning.
So needless to say he brings many perspectives to the podcast table when he joins me to dissect and analyze the ECB’s decision to hold its key rate steady after holding it steady for over a year.
As EU policy makers wait to see how big the tariffs are that President Trump finally imposes on the them, Vitor says this will definitely be key to determining how much growth slows and inflation falls in the months ahead and therefore whether or not the ECB cuts its key rate in the second half of the year year. More broadly he sees tariffs causing deceleration in global growth that will be a deflationary impact as well.
He sees inflation falling “well below 2%” in the euro area in the second half of the year leading the ECB to cut its key rate again. This in contrast to market participants and economists who are now predicting no more rate cuts this year after ECB President Lagarde said the economy “is in a good place,” where it can follow a “wait-and-see” policy stance for the foreseeable future.
Besides anlayzing the ECB’s current policy moves, and teaching at the Instituto Superior de Economia e Gestão (ISEG), Vitor is sharing his views on the global economy and monetary policy in his Substack column, MacroViews. In fact, his recent column argues for what many will see as a heretical view that argues for central bankers to reject Volcker methodology, which calls for raising rates so aggresively that it of necessity causes recession, if and when it’s supply shocks that are driving up inflation.
So dive in and hear what he has to say. And check out MacroViews, right here on Substack, where he writes about high-level central bank issues in a way everyone - including me! - can understand. The link is posted below.
ECB waits and sees with inflation at target, tariffs to determine next moves
…everyone expected it. By the way, as you said yourself, because, in fact, the inflation rate in the euro area has been 1.9 in May, 2% in June. So exactly at the target, there are no really news, and everything now development for the future are very much dependent on what will be the final deal between the Us. And the EU regarding regarding tariffs.
Pressure to grow for ECB fall rate cut as it grows now for Fed 00:02:07:13
…the situation was stabilized in a way that the wait and see is totally justified. So, for a while there will be nevertheless a lot of pressure and in the fall for a further cut like for the Fed in the US, I think
Core inflation rate above ECB’s 2% target doesn’t signal headline rate to rise
…the core <inflation rate in EU> well, by the way, 2.3 is quite low because at the peak of the recent inflation period, the core inflation in the euro area was very high and that now 2.3 is really quite, quite low in the euro area. It can be shown econometrically that the core inflation is not a good leading indicator of future headline inflation. And so that connection and which is more relevant for the U.S. and then for the euro area also means that the core inflation rate as not for the ECB, the same role that it has for the Fed.
Not much guidance offered at ECB meeting 00:03:46:18
So now there was next to no future guidance. As you said, a lot is resting on what kind of tariffs are imposed on the EU by the U.S. and they're still not clarified.
Does a firming up of the tariff picture call for more guidance? 00:04:12:20
Not really, because nothing is certain regarding that. We don't know exactly what will be the negotiating position of the European Commission, which is interacting with the U.S. because, as you know, trade policy in the European Union is led by the European Commission. It has the competence to do that and to take the down decisions in that regard. And we don't know what may or may happen.
A base case for tariffs is emerging 00:06:06:09
But now taking what has been ongoing with other countries, as you said, the 15% <tariff> seems more likely than the ten <percent> as the base, the baseline. And that, of course, will entail in itself some decimal points, less in growth during three years for the euro area.
Tariff Deals with Trump struck at the cost of mistrust 00:08:09:18
The European establishment is very cautious about that. And also there is now a lot of mistrust.So and now they will become on the U.S. side quite significant. And if things don't go well, also, the the EU will retaliate and they have already prepared for that scenario. Let's see. I hope it won't materialize. This is a bad scenario and that in the end, the result can be such that the European Union can accommodate and not retaliate at the same level as the final deal will indicate.
Tariffs are an ill wind that blow no good 00:11:44:12
In my view, the result of the tariffs, which will decrease the growth of trade worldwide and will have a deflationary effect in the world, and that is seen around the world. If you look to the past five-months, you can find that that very high number of central banks felt already compelled to cut rates because they are concerned with growth of their economies. That's an important sign that the world is going into a significant deceleration of growth because of the new U.S. trade policy. Mostly there are other factors, but that is the more important one…
Tariffs on top of other challenges 00:14:44:24
Also, we have to be aware that the potential growth of the euro area and of the U.S. are much lower than people still have in their minds thinking about the past, because right now the potential growth of the euro area is 1% to 1.1% because we already have our population in at working age, decreasing, decreasing already. So the demographic factor already is negatively affecting the potential growth, not in the U.S. yet, but nevertheless, there was a deceleration and the Fed assumes potential growth for the U.S. economy 1.8%.
Impact of bumped-up NATO Spending – who knows? 00:16:30:04
Well, we don't know yet. There was this commitment in NATO in the latest NATO meeting with with the U.S., with these, you know, and the stratospheric target of 5% of GDP that the U.S. does not attain right now.. But, of course, the 5% includes things that are not oddly out, military and equipment, but also things that are that contribute to the defense of any country, which means that in terms of pure art, military equipment, the commitment is to increase expenditure to 3.5% of GDP, whereas today the EU is on average at 2%.
Germany has a plan for increased military spending 00:18:22:03
… other countries that don't have space that they will have to be much more gradual in regards to defense, so much that that will be not enough to offset the adverse scenario that you mentioned before.
Slower wage growth means inflation well below 2% in second half 00:19:15:22
There are different views, but… my view is the following. Inflation in the second half of the year will be well below 2%. It's now at two, but it will be well below 2%. The indicator is about wages negotiated and what the indicator that the ECB has offered the wage tracker, which is also about the future because it takes the contracts that have been signed and then foresees what will be the wage growth in the next month as it comes to a wage growth by the fourth quarter of just 1.6%.
MacroViews: Out with Volcker Methodology when supply shocks drive up inflation 00:18:03
And so on, Contrary to what happened in the control of inflation in the late seventies and early 1980s, where there was a huge recession at the time. In fact, in the US, the biggest recession since the big depression, you mean at the same time that was a very deep and long, the price of oil tripled in 74 and increased, again, 100% in 79. so the three factors that explain why this time there was no need for a recession to bring inflation. In the first place as it happened in all historical examples of price, price spikes induced by big external shocks, wars or commodities, where we see that of course that supply shocks cannot continue every year. Number two is that that this time there were no wage price spiral spiral. Contrary to what still existed in the seventies and eighties. There is a big institutional change in the institutions of labor markets with the waning of the strength of trade unions and of collective bargaining. And the third factor is that central banks did not increase policy rates above inflation during these years. The first three years of the inflation episodes and the three factors together explain why a recession didn't happen and was not necessary.
