Interview with Reuters
Interview with Isabel Schnabel, Member of the Executive Board of the ECB, conducted by Balazs Koranyi, Frank Siebelt and Francesco Canepa
28 May 2021
What is your assessment of the economic outlook, particularly in comparison to your last projection made in March?
We have reasonable confidence that we have reached a turning point. The pace of vaccinations has accelerated, infections are going down and containment measures are gradually being lifted. Sentiment indicators have come in quite strong recently, not only in manufacturing, but also in services. So, we are seeing a surge in demand, which sets the stage for a firm recovery. Consumer confidence is also picking up quite sharply. At the same time, fiscal and monetary policy remain very supportive. The short-term outlook has brightened.
Are we still in an emergency? What are the criteria to declare the end of the emergency?
We are still in the middle of the pandemic. It is far from over, neither from a health nor from an economic perspective. But we are seeing substantial progress, helped by the extensive policy support. We can be confident that a large share of the population will be vaccinated by the end of the summer, which makes new containment measures less likely. But a relatively large part of the economy remains in a state of emergency. Activity and employment are still below pre-crisis levels and the recovery remains uneven.
From a monetary policy perspective, the main thing to look at is the inflation projection. This is the ultimate yardstick against which we measure whether the emergency is over, since we said that our tools are meant to offset the negative effect of the pandemic on the inflation outlook. The recovery still depends on continued policy support. A premature withdrawal of either fiscal or monetary support would be a great mistake.
In December 2020 we made clear that our support would be there until the end of the pandemic period. It will be there at least until March 2022 or until the Governing Council judges that the pandemic crisis phase is over. Our intention was to remove uncertainty about a premature withdrawal of support.
Should we expect an increase in your growth projections?
It’s too early to tell, we will have to wait for the numbers. But in any case, projections in these times are surrounded by an exceptional degree of uncertainty because we are in a crisis that lacks a precedent in the recent past.
Given that nominal yields have risen but real yields have not, are we still enjoying favourable financing conditions?
Some of the increases in nominal yields have reversed lately and the President’s communication of last week was important in clarifying certain aspects of our policy.
I’ve always stressed that when it comes to favourable financing conditions, it’s insufficient to just look at the numbers. We have to understand the drivers behind the movements. It’s instructive to compare what happened recently to what happened at the beginning of the year. There are notable differences. Most importantly, recent yield developments were more clearly related to an improvement in the euro area’s growth outlook rather than to foreign spillovers. Rising yields are a natural development at a turning point in the recovery: investors become more optimistic, inflation expectations rise and, as a result, nominal yields go up. This is precisely what we would expect and what we want to see. It’s therefore important to also look at real rates and, as you say, real rates have been broadly stable. So, from this perspective, I would certainly say that financing conditions remain favourable.
At the same time, government bond yields have recently been rising more quickly than risk-free rates, even for the safest bonds, such as German Bunds. We are attentive to such developments because they may point to changes in the expected amount of duration supply, and this could be related to expected changes in our asset purchases. This would be a source of concern.
Is it time to reduce the pace of PEPP purchases to levels before the March increase?
There is one fundamental misunderstanding about PEPP and it’s related to the current public discussion about tapering. In December we committed to preserving favourable financing conditions until the Governing Council judges that the pandemic crisis phase is over, but at least until March 2022. This implied two things: first, the PEPP is linked to the pandemic and, second, the volume of our purchases is data-driven. In June we’re going to look at the drivers of financing conditions, we are going to consider additional aspects such as seasonality, and we’ll analyse the inflation outlook. This joint assessment will then determine what is going to happen with our asset purchases.
The whole concept underlying the PEPP is inconsistent with the idea that there will be a mechanical tapering of asset purchases. We always have to be willing to reduce or increase asset purchases in line with our promise to keep euro area financing conditions favourable and to offset the impact of the pandemic on the inflation outlook.
Some of your colleagues have explicitly come out in favour of keeping the pace of PEPP purchases stable at the June meeting. Do you also have such an explicit view?
One cannot give a firm answer at this point without having seen the data. This is an essential element of the PEPP: we don’t announce in advance a specific volume of purchases that we are going to have every single month; rather, we assess financing conditions jointly with the inflation outlook and then take a decision based on these data. That is very important to me.
You also have a quantitative target, which is the size of the envelope. That is why some people say you either taper or increase the envelope. Is it time to discuss increasing the envelope?
The remaining envelope is quite large. For now, it doesn’t impose any restrictions on our decisions. It is therefore premature to talk about things that will become relevant only well into the future. It will all depend on two things: on how financing conditions evolve and on when the pandemic crisis phase is over.
PEPP was launched as an emergency tool to deal with the effects of the pandemic. Could it end up staying until inflation converges to the ECB’s target?
It is not the objective of the PEPP to bring inflation fully back to 2%. PEPP is designed to counter the downward impact of the pandemic on the projected path of inflation. We have other tools to bring inflation back to our aim. We should not forget that we continue purchasing €20 billion every month under the APP.
At what point is the steepening of the yield curve damaging and inconsistent with favourable financing conditions?
It all depends on the underlying drivers. If the economy improves, yields, nominal and real, will go up at some point. Yield increases will only be harmful if they are not accompanied by an improvement in the outlook, or if they are disorderly. It depends on this distinction, whether a yield curve steepening is considered benign or not.
Some of your colleagues say the ECB will need to rotate at some point from PEPP to APP. When should this rotation start and what conditions are required?
I wouldn’t use the term rotation here. PEPP and APP are separate programmes and serve different purposes. PEPP aims to offset the negative impact of the pandemic on the inflation outlook. The PEPP will end when this has been achieved. We are not seeing this yet.
But, ultimately, getting back to the pre-crisis inflation path is not enough. As things stand today, it’s likely that when the PEPP ends, we will not have reached our medium-term inflation aim of below, but close to, 2 per cent. In that case, we will continue to run a highly accommodative monetary policy also after the PEPP. This not only includes APP, but our other monetary policy tools such as the TLTROs, negative interest rates and forward guidance.
Do you think it would make sense right now to consider a rate cut to stem the appreciation of the euro exchange rate?
It makes a big difference whether the euro appreciates in the context of an improved economic growth outlook or because of expected changes in our monetary policy. These drivers directly determine how the exchange rate is affecting medium-term inflation dynamics, and this is what ultimately matters. This type of analysis is important to see if our monetary policy is calibrated appropriately. At the current time I don’t see the need to adjust the deposit facility rate. However, we always stress that this is one of the instruments that we have in our toolkit and that we could use if needed.
How will the recent commodity price rises impact the medium-term inflation outlook?
In our baseline, we assume that the factors we are seeing today are transitory. But we cannot be sure.
To see this, it is useful to distinguish two types of factors. On the one hand, there are technical factors, like base effects. These we understand well. A large part of the volatility of inflation this year will be driven by these factors. It’s perfectly clear that we have to look through these temporary effects, and this has to be explained to the public.
The other factor relates to how supply and demand are going to interact when the economy reopens. It is much harder to assess how persistent these effects will be.
At the moment, demand is surging while supply is plagued by bottlenecks and supply chain disruptions. This has implications. We see that delivery times have gone up quite substantially, the ratio of orders over inventories has gone up and producer price inflation has accelerated.
The question for us is how this will translate into consumer prices. Before the pandemic, cost-push factors were often absorbed by profit margins. Now, we have to see whether it stays like that in a situation where firms are suffering because of weaker balance sheets and where there is a lot of pent-up demand. And should the pass-through be higher than in the past, it could also be the case that there are second-round effects with increases in wages.
But all this is highly uncertain and we cannot at this point in time be sure of what is going to happen. Our baseline is that it is likely that most effects are going to be transitory and that at some point the bottlenecks will disappear. But there is also a risk that it’s going to be different, so these are developments that we should watch very carefully.
The governor of the Banque de France made the case the flexibility built into PEPP to be carried over to APP and he mentioned flexibility in the pace and jurisdiction of purchases. Is that something that you would support?
This is something that would have to be assessed very carefully, so it’s too early for me to make any statements on this. We’re soon going to come out with a new monetary policy strategy. As part of this review, we will reconsider all of our instruments and ask ourselves how to best move forward under our new strategy. That is the moment to discuss adjustments to our tools.
Would it make any sense to remove the reference to a “significantly higher pace” of PEPP, which is quantitative rather than qualitative in nature, from the policy statement to make it clear that purchases depend on financing conditions and not on a pre-determined volume target?
Significantly higher is not a quantitative statement, it just indicates a direction in the volume of purchases that was taken in response to developments in the markets that we considered premature at the time. I don’t think this stands in contrast to the idea that we don’t want to make quantitative announcements.
Would you be in favour of just saying something like “the pace of the PEPP will be adjusted based on financing conditions”?
I guess markets will be interested in knowing the direction of adjustment. I don’t see anything that speaks against including an indication of that in the policy statement.
Now to the review that you’ve just brought up. Would you support taking a leaf out of the Fed’s book and having an average inflation target, albeit with a lot flexibility around it?
We should reconfirm our commitment to symmetry with respect to the definition of our price stability objective. It should leave no doubt that we take risks of too low inflation just as seriously as risks of too high inflation.
There are also very good reasons to stick to the medium-term formulation. It gives us flexibility, for example to deal with supply-side shocks. It also clarifies that we cannot fine-tune the inflation process to the first decimal place.
An open question is whether we should tolerate higher inflation temporarily when we are in a situation in which inflation has been too low for too long, as is the case today. This is something that needs to be discussed in our strategy review. I would say that our current forward guidance already signals our willingness to do so to a certain degree because we say that we will not raise our policy rates until we see that the robust convergence to our inflation aim has been consistently reflected in underlying inflation dynamics. There are certainly ways to make this commitment clearer.
When it comes to going a step further towards average inflation targeting, I’m quite sceptical. Theoretically this is appealing, but the implementation faces substantial difficulties. It may heal one asymmetry, caused by the zero lower-bound, only to create another one. While it may be credible to keep inflation higher for a while when there has been an undershooting, the opposite is not so clear, because the associated economic cost would be substantial.
The implementation and communication of average inflation targeting are also quite tricky. How long should the period be over which the average is calculated? How much of that should be communicated? How would we deal with supply-side shocks that central banks typically look through? All this may create additional uncertainty.
And while this type of strategy appears attractive when inflation has been too low for an extended period of time, it may not fare equally well when the environment changes.
I personally don’t think we should follow such a strategy.
Is it time to start discussing an extension of the current TLTRO operation? Is it becoming semi-permanent?
The TLTROs have been, besides asset purchases, our main instrument to deal with the pandemic and have ensured that the bank lending channel has remained fully operational.
We still have three operations left until the end of the year, which implies there is still quite a bit of stimulus in the pipeline. Now is not the time to discuss further operations, but if we see that there is a need to do more we can do more.
Given the surge in excess liquidity, when are you planning to revisit the tiering multiplier?
Since the start of the pandemic, owing to the asset purchases and the additional TLTRO operations, excess liquidity has continued to increase. But the net costs to the banking sector are, in the aggregate, much smaller due to very generous conditions on our TLTROs. All this has to be considered together and, if we do that, we don’t see any particular risks to the bank-based transmission of our monetary policy. Therefore, there is currently no need to discuss adjustments to the tiering multiplier. But, of course, it is an instrument we can use if needed. The remuneration on the exempt reserves could also be adjusted, but at this point in time I don’t see any need for that either.
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