26.09.2022  Economic developments in the current inflationary setting and the economic policy response* Fundación la Caixa. “Economy and Society” lecture series Pablo Hernández de Cos Governor  *iEnglish translation from the original in Spanish. Ladies and gentlemen, first allow me to thank Fundación la Caixa for inviting me to participate in this series of lectures entitled “Economy and Society”, which has become a benchmark for in-depth analysis of current affairs. Against the current backdrop of high inflation and considerable uncertainty over the economic outlook, tragically marked by Russia’s invasion of Ukraine, the first part of my address will focus on describing the Banco de España’s diagnosis of the economic situation and outlook. I will then analyse the monetary policy response of the European Central Bank (ECB) to this setting and some of its possible effects on the Spanish economy. Lastly, I would like to highlight the role that other economic policies can play in tackling the challenges we currently face. 1. The main determinants of the current economic outlook Inflationary pressures are proving particularly high and persistent, causing significant drops in real income Inflation has surged persistently worldwide, becoming one of the major determinants of economic developments. The reasons behind the rise in inflation are manifold and combine supply and demand-side factors, whose weights differ depending on the geographical area in question. These factors include high commodity prices on international markets, production bottlenecks affecting certain goods (due to supply-demand mismatches triggered by the lifting of pandemic restrictions) and shipping bottlenecks.

The other scant quantitative indicators that are still available for the quarter, such as new car registrations or the retail trade index, on the demand side, and the industrial production index, on the supply side, tend to confirm the loss of momentum in activity. Among the confidence indicators, the August PMIs show signs of moderation in both services and manufacturing. Manufacturing, in particular, evidences the decline in new (both internal and external) orders. Industrial activity has continued to be weighed down by global supply problems (which are affecting the automotive sector above all) and by the escalation of input prices since 2021 H2 (which have affected a very high number of products). Economic projections have been revised down notably for growth and up for inflation The latest ECB projections for the euro area, in contrast to those published in June, include, in particular, new developments in the gas market. First, gas prices were revised up in accordance with developments in the gas futures markets. Second, and for the first time, a degree of gas supply rationing, albeit moderate, is assumed. This would be more significant in the countries that are more heavily dependent on Russian imports, which could even see some production cuts in the winter. By contrast, demand for gas is expected to decline. Euro area economic activity is expected to slow in the coming quarters, as a result of the loss of purchasing power stemming from higher-than-expected inflation, the decline in confidence and, in general, greater uncertainty.