How is the euro area economy holding up in the face of the Iran war?
Well, let me take you back to February 27th. Europe was really on a great path and was well positioned. So we had recovery underway. We were going to increase our projection. Most likely, inflation had been under control, oscillating around our 2% target for almost a year. And unemployment was at rock bottom and employment participation was still significantly higher. And then the war started. And that created a situation of, I think, increased fragmentation. Everybody talks about the asymmetry of the shock, which is one of the largest energy shocks that we have ever seen on a global basis. And with that going on, I think that there was a movement of more integration. So you have a fragmented world which becomes, I think, more fragmented. More fragmentation and determination to better integrate. So we are at this interesting moment where there is damage caused, there is value lost, there is destruction of that. I don't think that Europe is the epicenter of that. It's clearly Asia, which is the first victim of the situation in terms of economic losses. And I don't think that we should be forgetting the direct losses of people having died, being injured, being displaced, and the destruction that has taken place that will require reconstruction efforts. And that, I think, is and should be at the front of our mind as we look at the economic consequences on the world economy.
How much of a drag does it have on GDP forecasts again? Oil prices fluctuate so much.
The direct impact on GDP is going to be measured by the IMF, the World Bank, the OECD. To a lesser extent, because it doesn't have the whole constituency, but all of them are revisiting downward their projection. I think it's -0.3 compared with what they had expected. We are revisiting as well our growth forecast and our inflation forecast. We have published that, as you know, and we have revised inflation to 2.6%, growth to 0.9. And then the evolution is going to be a factor of how long, how deep, how propagated the crisis is. And we central bankers are left with defining the baseline, which is based on the most accurate information we have, what we think will happen. And because this information that we have is constantly changing and we have a high degree of unpredictability and uncertainty, we have to work on scenarios factoring in how high oil and gas and all six and derivatives of those products will be, how long it will last and how fast the situation will be recovered. And we keep looking at current data as they come in. And thanks to Bloomberg, for instance, this comes in on a very regular basis. And we try to figure out where we are relative to the baseline and where we are relative to the various scenarios that we have laid out.
And I think you laid it out as three scenarios, baseline, adverse, and severe. I would call the baseline the baseline and the other two the scenarios. So where are we now?
We are in between the baseline and the adverse. So we have baseline, adverse, severe, so currently. But you know, when I say currently, you have to look at the price of the barrel, the price of the various categories of fuel, the price of futures and all of that applied to gas as well to determine where we are exactly relative to these two. But we are somewhere, I think, in between the baseline and the adverse scenario.
How quickly can that change from baseline to scenarios?
It changes every day. So the difficulty of us central bankers is that we need to take a medium-term view. This is how we define our target. You know, this price stability that defines our mandate is done by reference to the medium-term results and at the same time facts, data. A number of ships blocked here, volume of oil extracted varies almost on a daily basis. So we need to do this somehow schizophrenic exercise of keeping our eyes on the medium term and making sure that we deliver on our mandate, but at the same time checking the data almost daily.
So what does it mean for monetary policy? Does the baseline already warrant a hike?
What it means for monetary policy is that we have to be completely agile and ready to move in the direction that is required. And second, we have to be data dependent, as we have repeatedly said. But it does not predicate as we speak today, Francine, that we will go in one direction or the other, and it certainly doesn't determine a rate path that I can confirm today. And any of the colleagues who are confident that it's going to be one way or the other, don't know, honestly. Does the ECB have a type? But don't forget one thing. The baseline and all our scenarios are designed and formulated with the incorporation of what the market assumes and no other monetary policy or fiscal policy decision affecting baseline or either of the two scenarios.
Do you think there's a tightening bias? The ECB.
No, I think we have a compass which indicates price stability predicated on financial stability. Those are the two. I wouldn't call them bias.
How different is it from the shock in 2022 and how different will your response be?
Well, it's different from 2022 in many ways. If you look back, inflation was completely different. Interest rates were completely different. The shock was a combination of supply and demand. It was a vastly different situation. And I think Europe was affected in a much more significant way than it is at the moment because we had this sudden stop that came out of the unjustifiable war of Russia against Ukraine, which brought to a halt the delivery of gas. That was very sudden. I mean, at the time, central banks were blamed for acting too slow. Is there a danger? I mean, how does that impact, again, your thinking this time? Look, I think we've said very clearly that we would need data to act, but that we would not hesitate to act. I think it really captures well the position that we have. We need the data in order to analyze whether it's a see-through, is going to be short-lived. We will get back to the past, if you will. Although I don't think that's actually possible. And we need all that. So it's either the see-through, which doesn't require that we take any particular decision, or it's going to be long-lasting. It will peak higher and it will require action on our part, or it will be somewhere in between, which will then require a judgment on the part of the Governing Council to decide whether or not the indirect effect and the risk of secondary effect might anchor expectations, which then would require action as well.
So I was at a dinner yesterday with the Treasury secretary who was saying that actually he thinks this will be short-lived, but he's a political leader as well as being a terribly competent person. But he's a political leader.
I'm not a political leader anymore. And our job as central bankers is to stay in our line, to observe our framework. We have one. Thank you very much. And to identify whether or not we are in the situation of short-lived, look-through, or long-lasting, act and possibly decisively, or in between, which requires a very subtle identification of how much, when, in order to make sure that inflation expectations are anchored and we do not get the secondary effect. So that's the job. It's the difficulty of what we have to do at the moment, while at the same time very seriously looking at the medium term and being attentive to the short term.
And so your gut feeling for what we're living through now, you'll act quicker than in 2022.
I don't have a gut feeling, you know. When I hear the music of this is short-lived, we will go through that, you can see through. First of all, we decide what we have to do. Point number one. Point number two, you know, to explain to the fishermen who cannot go at sea because he cannot pay for his petrol. Or when I think of the households that don't know whether they'll be able to pay for the refilling of their fuel tank, or whether I think of the guys who have to drive to work and who see the price of oil at the pump going up and up and up. I take the see-through story into account, but this is not something that you can actually explain, which requires from our perspective in order to align in the most effective way monetary and fiscal policies. It requires that we have a dialogue with the fiscal policy leaders and ask them to be targeted and temporary, transparent and tailored and all those T's when they design support packages or help for the people who are the fishermen, the housekeeper, the household, or the guy who is driving his car.
Given where we are now, what does the worst-case scenario for growth and inflation look like?
The worst-case scenario is war. In any event, you know, as former head of the IMF, I have seen successful programs being completely wiped out by war. So war is, in any circumstances, the worst outcome. If you talk in strict economic terms and the movement of goods and all that, it's the Strait of Hormuz not being open for shipping and transportation because you have 20% of goods are not going through that, as well as other ingredients necessary for fertilizers, ingredients necessary for microchips and what have you. Not going through the strait.
So what's the pain threshold for the euro area economy that the ECB would have to act on? Is it inflation at 3%, 4%?
Look, we have forecasts for inflation that vary between 2.6, which is the baseline that we have, and a little north of 4%. Based on what I told you earlier, which is see-through, strong, decisive reaction, or somewhere in between, depending on the factors that we see, we will adjust because we will be agile. But one thing for sure is that we will keep our 2% target together.
How worried are you about the discrepancy between spot and future oil prices and so potentially tighter markets that we're pricing in?
