Quiet confidence of a new-age banker

Date: 21/05/1998

Euro-zone central bankers may come in different shapes and sizes, but when it comes to monetary policy they sing a very similar song these days. Tim Jones talks to Lisbon's man on the future governing council of the European Central Bank

NO CUSTODIAN of the value of money could possibly have enjoyed the unseemly squabble between EU leaders over who should become the first president of the European Central Bank.

However, by their reaction to the May Day weekend summit and the eventual decision to limit Wim Duisenberg's presidential term at the ECB, the financial markets made it plain that their faith in the new bank had been neither shaken nor stirred by the fuss.

Whether the ECB is run by the Dutch president of the European Monetary Institute (EMI) or Bank of France governor Jean-Claude Trichet is a matter of indifference to the world's money-changers.

António José Fernandes de Sousa, governor of the Banco de Portugal, explains why.

"When you look around the EMI council or other groups of central bankers, you have to conclude that we are similar enough for it not to be important who is on the board of the central bank," he says.

"More than in most other areas, monetary policy has a technical basis and is more immune to differences in style."

That was not the case even in the recent past.

A generation of central bank governors in several European countries were government placemen who had to carry out the politicians' bidding or face the sack.

But now, with the imminent advent of the euro, virtually all the EU's national central banks are independent from elected governments and parliaments and have one overriding goal: to keep prices stable.

Their only real tool for achieving this is changing the cost of borrowing by raising or lowering interest rates.

Differences might emerge between central bankers on the timing of these rate changes - as has been amply demonstrated on the boards of the Bundesbank, Bank of England and US Federal Reserve - but the ultimate goal of fighting inflation is adhered to by everyone.

De Sousa is one of the new breed. The experience of the 43-year-old banker, educated at the Universidade Católica Portuguesa and the University of Pennsylvania's Wharton School, belies his youth.

Having taught at the Universidade Católica for 16 years, he moved briefly into commercial banking before entering the government first as deputy trade minister in 1991-93, as the escudo joined the Exchange Rate Mechanism, and then as deputy finance minister in 1993-94 during a traumatic period of devaluation for the currency. He was appointed governor of the Banco de Portugal in June 1994.

De Sousa does not expect to see wide divergences of opinion on the goals of euro-zone monetary policy when he joins the 17-member governing council of the ECB next month. Yet differences over tactics are bound to emerge.

At some time, decisions on interest rate changes will have to be taken by a majority vote. In the UK and the US, the central banks publish the minutes of their meetings and a record of who voted which way - a practice which the European Parliament is keen to replicate at the ECB.

De Sousa is sceptical, however, at least in part because of a bad experience at home.

"In a small country, that kind of transparency could lead to misinterpretations nationally and internationally, particularly if there are problems of translation," he says.

"Portugal went through a foreign exchange problem in 1994 due to a news agency which reported an announcement of a meeting of the conseil d'état as a coup d'état.

"Admittedly, at the European level, transparency would have to be greater. But too much transparency, at least at the beginning, could be harmful to defining policy.

"One of the dangers could be that newspapers and agencies would say 'the Belgian member said this or the French member this or the Portuguese that'. It would look as though we were defending our national rather than the European interest."

Once economic and monetary union begins, central bank governors from small countries will have to take special note of risks of inflation or deflation at home, which is something the Frankfurt-based directorate will not do.

But De Sousa believes that this dichotomy of views is also exaggerated.

"In a large economy - as Europe will be - we will have to look at the overall area when setting policy and, of course, the largest countries will have more impact than the smaller ones in terms of the effect of the decisions," he says.

"Someone from a small country will understand that Germany and France will have a greater impact on the consumer price index. That's just mathematics."

These economic divergences are already apparent seven months before EMU starts.

Germany, France, Belgium and Austria are just beginning their economic upswing with hardly an inflationary peep. As a result, their short-term interest rates are just 3.3% while, in Ireland and Italy, they remain over 5% and in Portugal and Spain over 4%.

Getting their interest rates down to the level of those at the 'core' before the end of December this year is vital if these countries are to avoid a nasty economic shock. Yet precipitate rate cuts risk unleashing inflationary pressures.

"I am quite sure that Portuguese rates will converge to German and French rates," says De Sousa.

"I don't know whether their rates will be 3.3% by the end of the year but, if they are, they will be the point of convergence since the whole idea of convergence has been to obtain the best values and not averages."

Last week, the Bank of Portugal cut its key 'repo' rate (the rate at which it lends money for very short periods to the commercial banks) from 4.7% to 4.5%. This brought the gap, or 'differential', between Portuguese rates and those in Germany to 1.2 percentage points.

Since the beginning of this year, the central bank has eased rates in steps of 0.2 percentage points in January, February, March and May.

"That doesn't mean we are going to decrease by 20 basis points every month, but it is certainly a step-by-step approach," explains De Sousa. "Last year, we cut for three months in a row and then went four months without doing anything, so you cannot extrapolate too much."

He is not worried about closing the remainder of the gap with Germany.

"The differential we have is still less than the amount we cut rates last year and the impact on inflation then was almost nil," he explains, expressing confidence that the annual inflation target of 2% set by his bank will be met even though interest rates will certainly fall.

"We have to take into account whether a rapid decrease in rates would have an impact on the value of the escudo since stability is our overriding aim," he adds.

"The economy will not feel a major impact because of what we do with very short-term rates. In a small, open economy like ours, the external value of the currency is more important in terms of determining inflation than the internal interest rate. Interest rates have an impact on the value of the currency and, through this, can feed into inflation.

"But it is not so direct an impact because we are price-takers in the market and not price-leaders - except, perhaps, in cork."

De Sousa's philosophy can be summed up in his parting comment at the end of the interview: "Monetary policy should be noticed and not talked about. That's the reason I usually don't talk."

Major interview with the Governor of the Banco de Portugal, Antònio José Fernandes de Sousa.