26. 09. 2022 economic developments in the current inflationary setting and the economic policy response * fundacion la caixa. “ economy and society ” lecture series pablo hernandez de cos governor * ienglish translation from the original in spanish. ladies and gentlemen, first allow me to thank fundacion 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 espana ’ 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. lifting the health restrictions has also resulted in some of the demand for services being released, prompting an acceleration in recreation, hospitality and tourism prices. in addition, changes in practices, such as the rise of working from home, have led to higher spending on household appliances, exerting further pressure on their prices. in the case of the euro area and spain, analysing the disaggregated data reveals the following stylised facts : 1. the magnitude of the increase in inflation is unprecedented in recent times. in the euro area, august saw the harmonised index of consumer prices ( hicp ) reach 9. 1 %. in spain, it has risen from slightly negative rates at end - 2020 to 10. 5 % in august 2022. for context, to encounter a similar rise we need to go back to 1977. 2. this inflationary episode is characterised by its high

relates to possible second - round effects, i. e. when high inflation passes through to wage increases and these, in turn, push up consumer prices to the extent that firms seek to maintain ( or widen ) their margins. again, this would make inflation far more persistent and increase the likelihood of the feared de - anchoring of inflation expectations. as i said, while there is no evidence of such effects occurring at present, at least on a widespread basis, the current high inflation does make this more likely. naturally, the extent of the economic downturn – over which, as i indicated earlier, there is significant uncertainty –, and its effects on wages and profit margins, will be a key determinant of the medium - term inflation outlook and, therefore, of our monetary policy decisions. ultimately, our next decisions will be based on the incoming data and their implications for achieving our medium - term inflation target, in line with the “ meeting - to - meeting ” approach that we have adopted. in any event, interest rates will have to reach a level that allows us to ensure a gradual convergence of inflation to our medium - term target, and how quickly we reach that level will be conditioned by the same target. whether this means reaching interest rates at levels close to neutral or higher will therefore depend on that target. the normalisation of monetary policy is prompting a tightening of financial conditions. the process of monetary policy normalisation has translated into a significant increase in market interest rates. since early 2022 the 12 - month euribor has climbed by more than 290 bp, while the 10 - year overnight index swap ( ois ) rate ( typically used as the risk - free benchmark interest rate ) has risen by 240 bp. these increases have begun to pass through to the cost of bank financing for firms and households, which will help to contain inflationary pressures. in spain, long - term government bond yields have risen by 2. 5 pp this year, and the risk premium relative to the german benchmark has increased by 35 bp, although it has remained stable since the tpi was approved. meanwhile, the average cost of long - term corporate debt issuance has also risen sharply ( over 220 bp ) and, as with public debt, has reached levels not seen since 2014. moreover, the ibex 35 has fallen by nearly 11 % since early 2022. the impact on bank lending conditions has been more subdued. the average cost of new loans rose up to july ( latest available figure