Exclusive: ECB officials saw March HICP forecast as too optimistic, Econostream understands

1 April 2022

By David Barwick – FRANKFURT (Econostream) – The latest baseline scenario of the European Central Bank, updated at the Governing Council monetary policy meeting last month, was never really valid, and policymakers increasingly see the euro area economy as being in one of the less optimistic scenarios the ECB presented at the time, Econostream understands.

In the view of a participant in the meeting of March 9 and 10, the fact that the updated forecasts lacked validity was already apparent at the time they were first shared with Council members.

‘Already during the meeting, it was clear that the baseline scenario is just too optimistic anyway, in terms of both growth and inflation’, this person said.

‘I think we are much more in the other two scenarios at the moment, whether it’s the more severe one or just the adverse one’, the person said with respect to the current alternatives to the baseline. ‘It’s hard to tell.’

The problem, he said, is that ‘the underlying assumptions were made at a time when the war was just beginning and no one had any idea what would happen.’

That may be a somewhat charitable interpretation. ECB Chief Economist Philip Lane announced late on March 2, one week after the outbreak of war, that the forecast exercise had been modified so as to include both the February inflation data and the implications of Russian aggression against Ukraine.

Although from today’s perspective it turns out to have been early days, it was already apparent that democratic states were determined to go all out to oppose Russian fascism by means of sanctions and military support for Ukraine, and that Moscow was not going to seize Kyiv in three days.

Nevertheless, despite a wide range of factors that would seem to have argued for more significant revisions, the ECB on March 10 unveiled updated projections showing that Eurozone inflation would climb to 5.1% in 2022 from December’s estimate of 3.2% but then conveniently weaken to 2.1% in 2023 and 1.9% in 2024, not all that far from the previous forecast of 1.8% for both years.

In conjunction with its baseline, the ECB shared two alternative scenarios – ‘adverse’ and ‘severe’ - on March 10. The fact that both were worse than the baseline is itself an indication that the baseline was viewed by staff as more likely to prove optimistic than pessimistic. During the pandemic, the central scenario was accompanied by a (relatively) mild alternative on the one side and a (relatively) severe one on the other.

‘I can’t buy the figure for 2024, because it’s so far off and there are so many uncertainties and unexpected developments, not only in the economy but also the world’, another participant in last month’s meeting told Econostream.

Lamentably, the fact that the forecasts were apparently always recognised as suspect has not deterred various Governing Council members, in particular those at the dovish end of the spectrum, from continuing to point to the projections as evidence that all is well from a medium-term perspective, with how well simply a detail.

‘In all scenarios analysed, inflation is expected to decline gradually and stabilise at levels close to our 2% target by 2024’, Banco de España Governor Pablo Hernández de Cos said Tuesday.

On the face of it, that is a statement of simple fact. But the point is that if the ECB’s baseline was never valid, it can reasonably be asked on what basis, in an environment the ECB itself stresses is characterised by extreme uncertainty, anyone should put much stock in the alternative scenarios, especially when they come to such a convenient conclusion.