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Interview with Market News International

Interview with Luis de Guindos, Vice-President of the ECB, conducted by Luke Heighton on 29 September 2020

1 October 2020

The September 2020 ECB staff macroeconomic projections appear to have added weight to the ECB’s baseline scenario. How do you interpret the most recent growth and inflation data? Is there a danger that they could be viewed too positively, or too negatively?

First of all, it’s implicit in our projections that for the rest of this year the inflation rate is going to be hovering around zero to negative, partly because of the pandemic and the evolution of the crisis, and partly because of VAT rebates – not only in Germany, but also in other countries like Ireland. These are ephemeral effects, one-offs. For 2021, the base effect is going to play in favour of a rebound in inflation, because the VAT rebates will disappear and the price of oil is most likely not going to continue declining. So we expect to see a certain bounceback of the economy that will have a positive impact on inflation. And finally, in 2022, we are projecting that the inflation rate will be on average 1.2-1.3%. But the further ahead you look, the more difficult the projections are.

So, we are discounting that for the rest of the year the inflation rate will be negative or very close to zero. And there are two forces that are at odds here. On the one hand, the pandemic. On the other hand, supply chains will become more regional, and this is something we need to look at carefully because it could offset the drop in demand. But we are monitoring inflation continuously, and as always we are totally open to recalibrating our measures in accordance with our inflation projections.

If we’re not out of the woods yet, when, if at all, might we expect discussion around an increase in the size or duration of the pandemic emergency purchase programme (PEPP), or another change in monetary policy, to take place?

If you look at the pandemic, there is a worrying increase in the number of outbreaks across Europe. At the same time, most governments have rejected the idea of a lockdown like the one in March. It seems we are entering the second wave of infections, but perhaps governments have understood that a lockdown as pervasive as the one we had some months ago would be a total disaster for the economy. So governments are trying to combine the public health element of the pandemic with keeping economies open.

Regarding our baseline scenario, more than focusing on the average, people should be looking at the dispersion around the average. This is relevant and makes a very clear point in favour of fiscal policy. Fiscal policy is the first line of defence. Some countries will clearly be below the average decline in GDP of 8%, but others will be well above. Fiscal policy has to focus on the latter group.

If that fiscal support, both nationally and at European level, is there, is it possible that we may see no further easing before the end of the year?

We need to look at the overall picture. I would not say that that’s necessarily going to be the situation. First of all, there is no evidence of financial tightening. This is something we have avoided. Then, we need to observe inflation developments. And we also need to keep an eye on how fiscal policy is implemented at the national and European levels. The PEPP is an emergency and temporary programme, tailor-made to deal with the pandemic. And we still have more than half of the total envelope available. We have not run out of ammunition at all. We extended the programme until at least mid-2021 and, if necessary, we could adjust and recalibrate it in the future. We have not taken that decision yet. And, in my opinion, it’s not necessary for us to take it immediately.

Is there currently a “sweeping review” of the future of the PEPP?

We are continuously assessing our monetary policy stance, and the PEPP is part of that. There’s not a specific moment in time to carry out a “sweeping review” of the programme. We do analyse our measures and economic developments at every Governing Council and Executive Board meeting, so I would not say we are going to select a specific moment in time to conduct a so-called sweeping review.

It would appear that there is some disagreement within the Governing Council over whether or when the PEPP should be expanded or extended. Would you say those favouring an expansion or extension of the PEPP currently make up a minority or a majority within the Governing Council?

We are implementing the programme. We have room for manoeuvre in terms of the envelope. We have time. We have flexibility. And everybody is quite happy with developments in the sovereign debt markets. There are 25 members of the Governing Council, and it’s normal for us to have different views. That being said, we have not discussed the extension of the PEPP. We increased the envelope by €600 billion on top of the existing €750 billion, and that was an almost unanimous decision. Nobody questioned whether or not we should increase the envelope. There were different views about the amount, but in the end the €600 billion figure got a lot of support.

Right now we are not having that discussion. It will come, but when exactly depends on the evolution of the pandemic, on the evolution of the economy, on the projections, on inflation, and on the situation in financial markets, as we are putting a lot of emphasis on avoiding a tightening of financial conditions.

It’s been suggested that we may never see a clear and definite end to the “crisis phase” of the coronavirus (COVID-19) pandemic. That would appear to have implications for the PEPP as a temporary emergency measure. If the PEPP is phased out, might some of the envelope allocated to it be transferred to the APP? Can the same be said of the flexibility afforded to the PEPP, in terms of capital key convergence and issuer limits?

We haven’t discussed that potential situation in the Governing Council. Let’s hope that the pandemic will start to fade away and that a vaccine will be available soon. I am sure that science will be able to deal with the pandemic. But then we need to see what the structural scars of the pandemic are, and how long it’s going to take to come back to the pre-COVID-19 level of output. And that takes me to the question of how to balance two different objectives: one being how to minimise the damage, and the other being how to avoid unnecessary fiscal, monetary or prudential stimuli. That is going to be the most telling moment. On the one hand you cannot withdraw stimuli too rapidly and, on the other hand, you have to be careful about the side effects of stimuli being too large. We need to convert the cliff edge into a ramp, and the ramp has to go in parallel with the trajectory of the economy.

The ECB does not target the exchange rate. However, it is carefully assessing exchange rate developments. If the euro strengthens rapidly, what can the ECB do to counter that movement?

There was an appreciation of the euro. We closely monitor the development of the exchange rate because it has an impact on the evolution of the economy and inflation. It’s not a policy target, but we do not overlook it, either. This is our approach. It was clearly expressed by the President in the last press conference.

Furthermore, if you look at the communiques of the G20, there is always a reference to the fact that economic policies in general, and not only monetary policies, should not target the exchange rate as this would lead to a currency war.

Yet there have been suggestions that some members of the Governing Council were unhappy with the lack of a more forceful expression of concern from the ECB with regard to the strength of the euro at the press conference following the last Governing Council meeting. One member said recently that “if the downward pressures jeopardise our price stability objective, we’ll have to intervene.” Does that not indicate the strength of feeling and a willingness to act that runs counter to what you’re saying?

I think it’s fully compatible. If any concrete situation or variable jeopardises our inflation objective, for sure we will react. That’s common sense, and it’s part of our reaction function. When we make our projections about inflation we take into consideration the exchange rate and its evolution. It is included in our models, and so indirectly it has an impact on inflation.

We’ve heard that it is the dynamics of the exchange rate rather than its level that is of principal concern. Have you given any thought to what dynamics would give you serious concern, and is there a level below which the ECB would prefer the euro to remain?

No, we do not have any concrete level at all. We take into consideration its evolution, and it is included in our models, but we do not have a red line. It’s much more a question of the trajectory of the variable.

Including if that level looks like becoming a permanent feature?

Again, I think this is not the case. We saw an appreciation. Afterwards the dollar appreciated a little bit against the euro. You have to bear in mind that if there is a market that has overreactions, it’s the foreign exchange market. Let’s give a little bit of perspective to the situation. For instance, a significant part of the appreciation of the euro occurred when the recovery fund was approved. The problem now is that growth is very low, and simultaneously there are some trade tensions. At the global level, the biggest mistake we could make would be to transform the trade disputes into a form of currency dispute. That would be suicidal and would repeat the mistakes of the Great Depression.

What are the implications for the ECB’s monetary policy strategy review of the Fed’s move to average inflation targeting? Is it something you would be in favour of? Is there a danger that a structurally dovish Fed leads to a permanently strong euro?

We always look at the Federal Reserve, as the central bank of one of the largest economies in the world, but our mandates are different. The Fed has a dual mandate, but we have only price stability as the primary mandate. So we look carefully, we communicate, but the situation here in the euro area is structurally different.

In our case the definition of price stability is relevant. But in my view the analysis of the instruments we have available to reach that target is even more relevant.

What are your personal ambitions for the outcome of the review? Is there anything you would particularly like to see or not see?

Observers are going to pay a lot of attention to the issue of the definition of price stability – whether and how it evolves. But in my view the key element of our discussion is going to be the instruments. How the instruments are pursued. How effective are they, what the potential side effects are. This is the most important part of the strategy review. But this is just a personal view.

Christine Lagarde recently described the coronavirus crisis as an opportunity to create the conditions for more inclusive, greener and more digital growth. Would you like to see the ECB be more assertive, or more expansive, in its interpretation of its secondary mandate responsibilities? Might that be one outcome of the strategy review?

The secondary objectives are going to be relevant. Central banks are not ensconced in an ivory tower. If you look at the EU’s priorities – and we have to support these priorities – there are two that are especially relevant: digitalisation, and environmental or climate change-related issues. We have started to consider how climate change would affect the solvency of banks and non-banks. We expect governments will start to apply fiscal policies and taxation policies to deal with climate change. These actions will have an impact on inflation and activity, and therefore we have to take them into consideration in our projections and reaction function.

Furthermore, climate change is becoming a financial risk. So what we expect, and what we are trying to foster, is that whenever we receive an assessment for a bond or an asset, rating agencies take into consideration not only the durational solvency and financial risks, but also this new dimension that is climate change. It may be very relevant in the near future, because this is one of the main guidelines we use to decide on our purchases.

Besides, the question of inclusion is important, and after the pandemic it is going to be much more so. But the main actors need to be governments through fiscal policy, taxation and expenditure, because all three can target the concrete segments of the population you want to address much more. Monetary policy, in terms of improving the economic situation, can have an indirect impact. If the economy grows, jobs will be created, and this will be a key element of any social policy. However, as a general guideline, fiscal policy should be the main tool used to achieve social inclusion.


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