Interview with Ta Nea
Interview conducted by Maria Vasileiou with ECB Deputy Governor Luis de Guindos
June 16, 2022
What led to the decisions made last week and what kind of rate hikes can be expected after the first of July?
Inflation is very high. Our forecasts show that it will only gradually begin to decline later this year and remain above our target throughout the forecast horizon. Inflation is more persistent and broad-based than we thought a few months ago, but will continue to decline in 2023 and 2024. The Governing Council of the ECB has indicated that it is fully committed to returning inflation to our definition of price stability – 2% over 2024 over the medium term – and has begun the normalization process. This includes the end of net purchases under the asset purchase program as of July 1. We have also given forward guidance on interest rates by announcing two increases in July and September. We plan to raise rates by 0.25% at our meeting on July 21st. For September, we can consider a bigger increase if the inflation outlook continues or weakens. Our future decisions are based on information.
Partly because the Fed and the Bank of England started adjusting their policies earlier, there has been criticism that the ECB’s rate hike is coming rather late…
First of all, I want to emphasize that we started reacting to inflation several months ago. In December, we decided to end Pandemic Emergency Purchase Program (PEPP) net asset purchases in March. And the economic situation in the euro area is not the same as in the rest of the world. Current inflation is a global phenomenon, although it started to affect Europe a little later than elsewhere, which explains why our response has been a little later than in other jurisdictions. As soon as we saw that inflation was taking root, we acted quickly and decisively. In contrast to the euro area, domestic demand appears to have been stronger than the rate of inflation in the United States.
Worried about secondary pressures?
This is a risk we have to take into account. Inflation is higher than expected for a longer period of time. The longer it stays high, the greater the likelihood of after effects. So far we haven’t seen any big increases in salary applications and settlements, but we have to monitor the situation very closely.
The ECB’s macroeconomic forecasts have been significantly revised downwards. Is there a risk of recession?
We revised down the growth outlook for 2022 and 2023 due to the weakening of the terms of trade due to the effects of the war in Ukraine and the rise in raw material and energy prices. As a result, we now have to allocate a larger share of the euro area’s income to consumption in favor of these more expensive factors of production. Measured by net income, households and companies are poorer than before the war. This factor is reflected in our growth forecasts. However, our baseline scenario shows that we do not have a recession (defined as two consecutive quarters of negative growth). But we have low growth. In extreme situations – such as severely disrupted energy supplies, as assumed in our calculation scenario – growth would turn negative in 2023.
Government bond yields are on the rise. Is there a risk of financial fragmentation and what instruments can be used if the reinvestment of PEPP income is not sufficient to prevent it? Do you think the market is testing you?
Fragmentation – or the weakened transmission of monetary policy – has always been a concern of the ECB Council. PEPP was launched with flexibility in mind, and this also applies to the PEPP reinvestment phase. Yesterday we also decided to authorize the relevant Eurosystem committees, together with the ECB units, to speed up the design of a new anti-fragmentation instrument for consideration by the ECB Council. There should be no doubt in the market about how decisively we will tackle fragmentation.
Greece is abandoning enhanced surveillance. You handled the Greek crisis as a member of the Eurogroup. How do you see the economic situation in Greece now?
The turnaround of the Greek economy has been impressive. The difference between the situation six or seven years ago and the situation today is like night and day. Today, people believe in the Greek economy. This is a clear sign of improvement in Greece, especially in three areas. First, its economy is now more competitive thanks to the structural reforms implemented. Second, it has a better financial position. Third, the Greek banking system is more flexible in terms of its capital and liquidity position. But there are vulnerabilities. The government should continue to strengthen the country’s fiscal position in the medium term by achieving consecutive primary surpluses, while the banking system should continue to reduce non-performing loans. The times ahead will not be easy – we have higher inflation, slower growth, higher interest rates and higher yields. However, I am sure that Greece will overcome these challenges successfully.
How are the euro area banks doing in the current situation?
European banks have been able to survive the pandemic, and they should also be able to survive the challenges brought by the war. They are better documented and more durable than they were. Although higher interest rates may in the short term improve banks’ profitability by increasing their margins, the transition of some banks in recent years from variable loans to fixed interest rates may negate some of these benefits. Not all banks are the same. Some are more sensitive to rising interest rates. The profitability and solvency of businesses can also be affected by a combination of slower growth, higher interest rates and higher input prices, which increases concerns about asset quality. In the long term, the situation of households and companies will play a key role when credit risk problems resurface.