Interview with Reuters
Interview with Philip R. Lane, Member of the Executive Board of the ECB, conducted by Balazs Koranyi and Frank Siebelt
25 August 2021
Could you give us an update on the outlook for the eurozone economy?
It’s important to differentiate between the first and the second halves of the year. It’s significant that second quarter GDP came in well ahead of our June projections. That reflects an earlier opening up, with many countries opening in the middle of the second quarter and onwards. The strength of the world economy and progress in vaccinations were also important factors.
In terms of the second half of the year, it’s still early days. But there’s probably some counterbalance to that good second quarter. The counterbalance is that it looks like bottlenecks are going to be more persistent than expected. There is also some moderation in the world economy, which is natural. And the Delta variant, although it has a more limited impact than earlier waves, remains a headwind.
If you put all of that together -- the fact that the second quarter came in above what we expected and what the third and fourth quarters might look like -- I would say we’re broadly not too far away from what we expected in June for the full year. It’s a reasonably well-balanced picture.
Does that mean you don’t expect substantial changes in the staff projections in September?
Staff projections are quite comprehensive and it’s too early to make a call on that, but I think I identified the big topics: the fact that the second quarter was ahead of expectations, but there are also some headwinds: more extensive bottlenecks, maybe some slowdown in the world economy and maybe some risk of the Delta variant.
What is the impact of China’s slowdown on the world economy?
The key question is whether it’s an organic slowdown. All economies slow down after the recovery from the pandemic. China went through the cycle earlier, so it’s natural that it would be slowing down at this point. But the real question is whether the extent of the slowdown is bigger than what’s already baked into the projections and I’m not so sure about that.
How is the Delta variant going to affect the economy?
It’s clearly a negative for the recovery in international travel and tourism. It’s a negative for the reopening of high contact domestic sectors as well. But the fact that it has not required more extensive measures and that localised measures have been reasonably effective does indicate that, in terms of the overall economy, the impact is quite limited so far.
The Delta variant is spreading around the world and came to the United States later than to Europe and it’s now part of the mix in the US and global economies. Because of high vaccination rates and prior lockdown measures, Europe may not be among the regions hardest-hit by Delta.
Europe is more the exception now, given the scale of vaccinations and the resolution of the vaccine supply problems. To me, attention may be rotating towards how the world is going to be affected by the next waves of the pandemic, even if Europe itself is going to manage this quite well, I hope. Vaccination is still incomplete, but the infrastructure is there, the system is there and that has eliminated uncertainty about Europe’s ability to carry out vaccinations.
Is it still appropriate to maintain “significantly higher” purchases under the Pandemic Emergency Purchase Programme (PEPP)?
The overriding aim of purchases is to maintain favourable financing conditions. Favourability is defined by whether financing conditions are sufficiently favourable to make sure we’re countering the negative pandemic shock to inflation.
The other ingredient is what’s happening to financing conditions. Market interest rates have moved down compared to the peak and are now in an intermediate zone: lower than in late spring, but higher than the very low levels we saw at the turn of the year. We’ll have to assess at the September meeting the appropriate calibration for the final quarter of the year, taking into account the movement in market interest rates and the inflation outlook.
But in the grand scheme of things, this is a local adjustment. Throughout the PEPP period, we have had a high rate of purchases. Purchases in the second and third quarters were significantly higher than in the first, but even in the first quarter, compared to historical norms, purchases were pretty high. Any adjustment we make within the pandemic period is within the single philosophy: maintaining favourable financing conditions. If this can be done with lower purchases, we’ll buy less. If favourable financing conditions require more purchases, we’ll conduct more purchases.
September is very far away, even from the earliest conclusion date of PEPP, which is next March. Our commitment to maintaining favourable financing conditions throughout the pandemic crisis phase means that the purchase decision should be viewed as an implementation issue. It’s subordinated to the deeper commitment, which is favourable financing conditions.
Given the drop in yields, couldn’t you maintain favourable financing conditions with lower purchase volumes?
It is a universal aspect of quantitative easing (QE) that today’s yields incorporate market expectations about future purchases. What we have implemented since last December is a dynamic process: we observe what happens in terms of financing conditions, especially market interest rates. We don’t respond day by day, but we did make a conscious decision in March to step up purchases, and we made a conscious decision in June that we should maintain that pace. In the upcoming meetings, whether September or December, we’ll have to take into account the movements in interest rates. Our tolerance for the level of financing conditions depends on how robust the inflation dynamic is looking.
As you said, March 2022 is still quite far off. Should we then expect a discussion in September about what happens in March and beyond? If it’s too early, how much time should markets be given?
Asset purchases will continue after PEPP because we’ll have our regular asset purchase programme (APP) running, as conditions to end APP are not there. That’s why we still have time. If we were in a pure taper situation, going from supporting the market to finishing net purchases, then preparing the market is an issue. But that is not the situation here. Regardless of when PEPP might end, that’s not the end of the ECB’s role in terms of QE. This is why we don’t need a huge lead time to think about it. Of course, we can’t leave it too late either. But six months is quite a lot of time. In the autumn, we’ll have to work through a lot of issues relating to what 2022 should look like.
We already know what we’re doing until March, which is maintaining favourable financing conditions, so we have time this autumn to work out what comes next.
We also know the autumn and the winter will give us further information on what happens to the pandemic, so we should use the autumn to think about these issues.
PEPP will continue until the crisis phase of the pandemic is over. What is your personal definition of the “crisis phase”?
For me, the crisis phase lasts while the downside risk is substantial. What we did last year and continue to do now, is provide a lot of stability. To me, the assessment is whether we’ve seen a sufficient reduction in downside risk that we can be comfortable in moderating policy support. PEPP is a crisis instrument. What we’ve done, along with public health and fiscal action, is to ensure that all sorts of downside scenarios have not come to pass.
At the same time, I’m sure risk tolerance will be something to think about, because you never have zero risk.
With inflation exceeding forecasts in the near term, how much impact will that have on medium-term price pressures?
Let me make a distinction between the expectations of financial traders and the real economy, like firms, worker representatives and households.
We’ve seen significant movements in the beliefs of financial traders, which is quite important because that influences asset prices. Over the course of the year, since the bottom seen last year, one narrative – a kind of pessimism that inflation was locked into a very low trajectory – has been repriced. Over the summer, you’ve also seen a narrative that a new chronically high inflation era is coming. That has by now also been repriced. So, there is a kind of reversion to the middle.
We need to observe whether the inflation readings we’re seeing right now will influence wage negotiations. I don’t see that at the moment, though there is often a lag in the wage negotiation system. You probably need to look across the full pandemic period because a lot of wage negotiations were postponed during the pandemic.
In 2020 inflation came in at 0.3%. In June we predicted that 2021 inflation would be 1.9%. If you put those together, you have an average of 1.1%. That’s broadly where inflation was pre-pandemic. The question is whether there’s going to be a radical shift in wage outcomes.
Does this mean that these near-term upside surprises are not changing your view of inflation in the medium term?
By and large that’s true, our view of subdued inflation pressures for the medium term still holds, but my first point also applies. It does serve to remind everyone that this type of fatalism that inflation will always be very low is being given less weight in markets. But equally, the kind of speculation that we are entering a chronically high inflation period is also seen as less likely.
Inflation expectations have not moved up significantly since you unveiled your new strategy in July. Did the guidance then achieve your goals?
There are two basic points to make. One: in relation to the two per cent symmetric inflation target, what we decided is not a really huge surprise given the discussion in the last several years. So, I’m not sure it should have led to a huge revision in market beliefs. Two: the rate forward guidance was more novel. I think the rate forward guidance will take on increasing importance as time goes by. I don’t think that should be evaluated primarily in terms of the announcement effect because nobody believes we’ll meet the conditions to lift interest rates anytime soon. But it is also true that as inflation goes up in the coming years, the rate forward guidance will provide discipline and strong guidance about our patience. It’s going to play an important role in ruling out speculation that – as the inflation environment improves – we might be tempted into premature tightening. It’s not so relevant now, because we’re not near that zone. But at some point we’ll enter that zone where inflation is rising and it’s moving closer to two per cent.
We understand from your strategy that overshooting the target may happen, but I have not got a firm enough answer on whether the ECB will aim to overshoot. So, just to be sure: is overshooting merely going to be incidental or will it be an aim?
It’s clearly the former and it’s important to recognise this distinction, because it’s a conscious one. To support these kinds of policy choices, for example, the rate forward guidance, we would run all sorts of simulations to assess what inflation would look like under various configurations of the economy. And the intention here is to deliver the two per cent inflation target. But if you keep with the rate forward guidance, it may imply a transitory period of inflation above two per cent. So, we recognise this is possible, we recognise under various simulations that this may well happen. But that is not the orientation. The anchor is two per cent. It is all about delivering two per cent. But to acknowledge that two per cent in the medium term may involve a transitory phase of inflation moderately above two per cent should be basically viewed in a “matter of fact” manner. It’s an implicit possible element of these policies, but it is not the goal.
The Federal Reserve is now openly debating tapering. How will their eventual decision affect the ECB?
The impact on the euro area is really a function of a few different dimensions. One is how much insulation might be provided by the exchange rate. If the exchange rate moves, counterbalancing monetary policy elsewhere, this insulates the euro area from some of those spillovers. In any case, the ECB is not a passive bystander. If there are spillovers to euro area financing conditions, we are willing and able to move as appropriate, as we have already demonstrated.
Of course, it is not a surprise that at some point the United States will end QE. So, it’s all about whether it’s a smooth process, which is already baked into financing conditions, or whether it contains some surprises.
The other basic point is that the US taper decision depends on substantial progress in the US recovery. Substantial progress in the US economy is good news for the world economy, it’s good news for Europe. So, it’s not a kind of random external shock.
Do you think investors are right to expect an increase in APP purchases once PEPP ends?
Whenever PEPP ends and we rely on APP as the primary QE instrument, the driver of policy will be the gap between where inflation is projected and our medium-term two per cent target. Our strategy is crystal clear, we will set monetary policy to deliver on our target in the medium term.
A second consideration is net bond supply. You cannot think about the volume of the APP independently of the volume of net bond supply. The relatively high fiscal deficits that we saw last year and this year will not be lasting in the coming years, but the scale of deficits may remain higher than the pre-pandemic levels.
A third element is investor demand: we have seen this year significant shifts in investor demand, and such investor demand shocks are relevant in thinking about the appropriate calibration of net asset purchases.
I think we have plenty of time to think about those questions.
What elements of flexibility from the PEPP should be carried over to the APP?
I think it is crystal clear that the parameters for flexibility should be different in normal times compared to a crisis. You can take the view that the ECB has shown that, when necessary, it can design a crisis programme pretty quickly.
The other dimension of flexibility relates to maximising the efficiency of the APP even in normal times. This programme has been around since 2015. We have learned a lot and it has been pretty effective, so there’s value in maintaining a well-seasoned, well-oiled programme. On the other hand, a principle of good governance does mean you take a look at the kind of basic design of any policy every so often.
Do you have any red lines in this flexibility?
Our policy decisions, including those on the design of the APP, should be based on an integrated assessment. Weighing different factors suggests that we should try to minimise the amount of absolute red lines, because we have an overriding price stability mandate to meet, and all characteristics should be assessed on whether they are desirable or interfering with us delivering our mandate. At the same time, of course, all has to be within the legal framework, which in the end is a set of red lines.
How vital is it to keep Greece in QE? It is part of the PEPP but not the APP. Can you foresee changes in your APP eligibility criteria tailored to keep Greece in QE?
There is a general point here: if you have favourable financing conditions, that benefits the bond market in general, not only the bonds we purchase. The impact of our policies is much wider than the individual securities we buy. It was very important to include Greece during the pandemic, because of the downside risk element of a crisis phase, and the PEPP has been very successful in this regard. And, of course, the PEPP will be reinvested at least until the end of 2023, so there will be a lot of ECB presence in the Greek bond market through the PEPP, regardless of whatever happens to the APP. The issue goes back to, it’s always reasonable to reassess on a regular basis the effectiveness and efficiency of how the APP is implemented.
We’re approaching the second to last TLTRO III tender. Is it time to discuss the future of the TLTRO programme?
It’s too early in the sense in that repayments are still some way off. We do have a window of time to think about whether any new programmes will be needed in the future. There’s no urgency about TLTROs.