European Central Bank officials are weighing the risk that the euro zone economy could shift into the institution's adverse scenario for inflation and growth, but they should refrain from hasty policy moves, according to Alexander Demarco, governor of Malta's central bank and an ECB policymaker.
Demarco said the ECB last month set out three possible scenarios for inflation and growth and that current developments have increased the prospect of the adverse pathway. "My impression is that at this juncture we could be veering towards the adverse scenario," he said on the sidelines of the IMF's spring meeting.
He added that if that adverse scenario were to take hold, then "two rate hikes anticipated by the market would be a reasonable expectation." That remark reflects how financial markets have already priced prospective tightening: a limited chance of a rate move at the ECB's April 30 meeting, with a hike in June largely expected and a second increase priced for September or October.
Despite acknowledging the possibility of a worse outcome, Demarco urged caution. He pointed to several factors that, in his view, reduce the immediate need for urgent action: longer-term inflation expectations look relatively well anchored, the ECB's credibility on fighting inflation remains high, and the central bank entered the current episode from a position of strength because policy rates are in a neutral range and price growth was at target prior to this shock.
"So far, inflation expectations are quite well anchored," Demarco said. "We need to be patient, not rush any decision and see what the data tells us." His comments underline a preference among some policymakers to let incoming indicators and surveys guide timing rather than pre-emptive rate moves.
Policymakers speaking on and off the record to market contacts have broadly downplayed the likelihood of a move at the April meeting, arguing that there is not yet clear evidence that energy-driven price pressures are becoming self-reinforcing. In that context, the ECB's own survey of business executives, due to be released ahead of the April 30 meeting, assumes greater importance as a potential signal of firms' pricing intentions.
Demarco said the business survey will be closely monitored because it could show whether companies expect to raise selling prices. "If expectations remain well anchored, the conflict proves temporary, and business signals do not suggest a big adjustment in selling prices, then there is a case for looking through this episode," he said.
At the same time, he conceded there are limits to how long firms can absorb higher costs. "There are of course limits to how much businesses can absorb," Demarco said. "They need to make a profit. This is why I think signals from corporations will be crucial." His emphasis on corporate profit margins and pricing behaviour signals an interest in microeconomic indicators as inputs to broader monetary policy decisions.
Context on market pricing
Financial markets assign roughly a 20% chance of a rate increase at the ECB's April 30 meeting, while a June move and a subsequent rise in September or October are more fully priced. Policymakers have flagged that, absent clear evidence of embedded inflation, immediate action may be unwarranted.
The balance of risks highlighted by Demarco places weight on incoming data, business surveys, and corporate pricing signals as the ECB decides whether to translate market expectations into policy moves.