Interview with Financial Times
Interview with Isabel Schnabel, Member of the Executive Board of the ECB, conducted by Martin Arnold on 14 February and published on 15 February
15 February 2022
What has changed since your December meeting that has made the ECB so much more concerned about inflation?
Last year, we were expecting that the sharp rise in inflation that we've seen in response to the reopening of the economy would subside relatively quickly because base effects were expected to drop out and bottlenecks were expected to be gradually resolved. What we've learnt over time is that high inflation is now expected to stay there longer. We've had two strong inflation surprises in both December and in January, which makes a reassessment of the inflation outlook necessary. In particular, it now looks increasingly unlikely that inflation is going to drop below 2 per cent by the end of this year, as we had expected earlier.
A reassessment of the inflation outlook has also become necessary in the light of three fundamental changes to the macroeconomic outlook. One is that the current Omicron wave is now expected to be more short-lived and less severe than previously thought. The second point is the strong data on the labour market. Labour market slack has been absorbed much more quickly than previously expected. We are seeing a historically low unemployment rate and a historically high participation rate, and surveys are pointing to strong future employment growth. Also, more and more firms are saying that a lack of labour is a factor limiting production. All this could imply that wage pressures are going to be stronger than we originally expected. This would be consistent with our survey among firms where a majority now believe that even though wage growth in the past was relatively moderate, it's going to pick up going forward. And finally, there is quite a bit of pipeline pressure. We've seen continued strong growth in producer prices. Part of that is only going to be passed through with a lag. And it seems that the pass-through can be expected to be stronger than usually.
All of this implies that it has become increasingly likely that inflation is going to stabilise around our 2 per cent target over the medium term. This means that we should start thinking about a gradual normalisation of our policy. In this there are two types of risk: There's the risk of acting too early and there's the risk of acting too late. We have to find the right balance between the two. With the most recent data, however, the risk of acting too late has increased and therefore we need a careful reassessment of the inflation outlook.
Given that oil prices are about 10 per cent higher than your last forecast in December, does that make it almost inevitable that the ECB will raise its inflation forecasts for 2023 and 2024 to at least 2 per cent in its next forecasts in March?
I think we really have to wait for the outcome of those projections. Rising oil prices have different effects. They tend to have a dampening effect on demand, even though fiscal policy is doing quite a bit, especially to protect the more vulnerable parts of society from the rise in energy prices. And then we have the direct and indirect effects of oil prices on inflation. So we really have to see what comes out of the projections, and I would not want to pre-empt that.
But the high level of inflation is mostly being driven by rising energy prices and supply chain bottlenecks and some people say monetary policy can do little to address either of those issues. So shouldn't the ECB look through these exceptional pressures from the supply chain and energy markets?
I've already pointed to the strong developments in the labour market. Labour market slack has been absorbed faster than anticipated and, as a result, wages may rise more quickly going forward. So there's a demand component in what we have seen and that's precisely what we have to look at. We also have to ensure that current high inflation does not become entrenched in expectations because that could then give rise to a wage-price spiral. We are not seeing anything of that yet. But we have to analyse this in a forward-looking manner and make sure that a wage-price spiral does not arise. Because once it's there, it's relatively costly to fight. So I think we cannot simply look through everything, especially if inflation now becomes more broad-based and more persistent than we originally thought.
If in future a conflict in Ukraine was to push up energy prices even further, would the ECB look through this in its monetary policy decision-making, or could it accelerate a shift to a less accommodative policy?
Geopolitical developments are part of our assessment. We are monitoring the situation closely. We would consider not only the impact on energy prices but also the broader repercussions on global and domestic growth and financing conditions. Given the likely negative effects of an escalation of the crisis on growth and confidence, including through potential sanctions, it is in my view unlikely that we would accelerate policy normalisation in such circumstances.
Markets are now pricing in several rate hikes by the ECB this year and a return of your deposit rate to zero by the end of the year. Are investors getting ahead of themselves?
Already before the February meeting, lift-off was expected around the summer of the year. That has to be seen in the light of the changes to the inflation outlook and the strong labour market. One should not take the market pricing of lift-off dates literally because it also contains risk premia, reflecting the high uncertainty that we are currently facing. So the actual expected lift-off date that we can take from the data is likely to be somewhat later. But as I said, and as President Lagarde also stressed in the press conference, we are acting in a data-dependent manner. We have a very clear forward guidance, which has defined conditions for lift-off, and I think markets are very well aware of that. Now we have to assess the incoming data and see whether these data fulfil the conditions. Let me also remind you that we have confirmed the sequencing of our different monetary policy measures. The forward guidance refers to interest rates and we said that net asset purchases are going to end before we are going to raise our key policy rates. So when we are discussing and reassessing the pace of our asset purchases, we have to be forward-looking and ask ourselves when we expect the conditions of our forward guidance to be fulfilled.
As well as a sell off in bond markets in the eurozone, we've seen an increase in peripheral bond spreads recently. How concerned are you about that trend? And do you think the flexibility of your reinvestments will be enough to counter any fragmentation in markets?
We've seen a general repricing in bond markets, which is not surprising given the change in our communication and the fact that the repricing started from very low interest rate levels. A particular challenge of the euro area is that a repricing of the risk-free rate may be accompanied by a change in sovereign spreads, which may then affect the transmission of our monetary policy to different parts of the euro area. We are aware that, given the euro area’s incomplete institutional architecture, parts of the single currency area remain vulnerable to a sudden shift in investor sentiment. Spreads generally reflect differences in fundamentals. But they can become destabilising when there is a lot of uncertainty or when there are self-fulfilling expectations. We therefore carefully monitor the developments of yields and spreads in the euro area, and we stand ready to counter severe market dislocations that lead to fragmentation. In the pandemic, flexibility in our asset purchases has played an important role. We have seen that that was a powerful instrument to counter the impaired transmission of our monetary policy. In our December decision, we confirmed the importance of flexibility and we said that in the event of renewed market fragmentation related to the pandemic, reinvestments under the pandemic emergency purchase programme (PEPP) can be adjusted flexibly and we consider this very important.
So are you concerned about the trend of widening spreads? Can you be a bit more specific on that?
Spreads have increased, but from very low levels and they remain well below the levels that we saw in the years before the pandemic. Governments will continue to benefit from the low interest rates that we've now had over a long period of time and also from the marked increase in the maturity of public debt. Therefore, even if current bond yields adjust upwards, average interest rates on the countries’ debt will stay low for an extended period of time. What also matters is that the euro area is expected to grow strongly in the coming years. Looking forward, it's absolutely key that governments invest and carry out structural policies that can lift potential growth. NextGenerationEU certainly plays a very important supporting role here. In a growing economy, rising yields are not a major concern.
When do you think the ECB net asset purchases are likely to stop?
All our monetary policy measures are guided by the inflation outlook. In March, we are going to look at the data that have come in as well as the new projections and then the Governing Council is going to evaluate the progress we have made in meeting the conditions of our rate forward guidance. And when we judge that the probability of meeting the conditions is sufficiently high, we will consider adjustments to the pace of our asset purchases, reflecting our sequencing. This implies that we will end our net asset purchases before the conditions of our forward guidance are fulfilled.
You have talked previously and warned on several occasions about the negative side effects of asset purchases. Do you think that they should be used only in exceptional circumstances? And are you not a fan of asset purchases?
I would not put it that way. I very much agree with our conclusions from the monetary policy strategy review that asset purchases are a standard tool in certain circumstances, in particular when monetary policy is constrained by the effective lower bound. Asset purchases are then an essential instrument to ensure price stability. However, we have to be mindful that asset purchases do have side effects and that these side effects are likely to increase the longer asset purchases remain in place. We're always very carefully assessing the proportionality of our measures. We look at the balance of benefits and costs and I would say that we are getting to a point where in light of the inflation outlook, the benefits of further net asset purchases may not justify the additional costs. Then there is an argument for ending net asset purchases. This decision is linked to the inflation outlook. That is important. So you cannot look at the side-effects in isolation.
If the Governing Council does decide that it's likely to meet the conditions for raising interest rates, will the ECB also change the calendar for reinvesting the asset portfolio that it has built up? Is the reinvestment period likely to be shortened?
In December, we already announced that we expect to end reinvestment under PEPP at the end of 2024. So far, we have not made any specific statement about the duration of the reinvestment under the asset purchase programme. In the current situation, we first have to focus our decisions on net asset purchases and the question of lift-off. The discussion regarding the size of our balance sheet after policy lift-off will be held in the future.
What about another tool that you've been using since the pandemic hit, which is the targeted longer-term refinancing operations, lending to banks at a subsidised rate of minus one percent if they meet certain lending criteria? That generous rate looks likely to stop in June. But when will it be time for these operations to stop altogether?
We have already announced that we expect the special interest rate period to end in June of this year. The special rate was indeed an extraordinary measure that was linked to the pandemic and it looks as if it is no longer needed. We are monitoring bank funding conditions, and we also have to carefully look at whether the maturing of our TLTROs will not hamper the smooth transmission of our monetary policy. I think the TLTROs have been a quite successful tool, they have helped reduce bank lending rates to very favourable levels, and they have contributed to preserving bank lending over the pandemic. But also for this tool, we now have to transition into the time after the pandemic. At this point in time, we don't have to take any additional decisions because the current round of TLTROs is still running until the middle of next year. The main decision that we have to take now is the question of the special interest rate period and there our current announcement is that this is very likely to end.
Some of your colleagues on the Governing Council have argued that the ECB should consider the effect of rising owner-occupied housing costs on the inflation figures and believe this takes you closer to achieving your targets in the medium term. What do you think about that argument?
In our monetary policy strategy review, we came to the conclusion that we need to take the costs of owner-occupied housing into account. Currently, the data is not sufficient, so there is a long process that has now been initiated in order to get a measure that is going to include owner-occupied housing at the proper frequency and also at the proper quality. But we have some preliminary data that we can look at and, in fact, the recent increase in housing prices has been unprecedented. If this were included, it would have a substantial effect on measured inflation, in particular on core inflation, where the weight of owner-occupied housing is larger. For example, in the third quarter of last year, core inflation would have been 0.6 percentage points higher, which is substantial. We cannot ignore this. It has to be part of our general considerations. One outcome of the strategy review was that for the time being our main inflation measure remains the harmonised index of consumer prices. When it comes to asking whether the conditions of our forward guidance are fulfilled, the President has always made clear that this is in the end not mechanically linked to the projections, but is a judgement by the Governing Council. And here, housing prices should enter in.
Do you have a sense of whether inflation is higher for low income households than it is for higher income households, or whether it's the same for all households?
Given that inflation is very high in the energy component and is also high for food, low income households who typically spend more on these types of goods are going to be affected more strongly. It is concerning that current high inflation is particularly painful for those households in the lower income category. But there is very little we can do about current high inflation. Even if we hiked rates now, this would not bring down today's energy prices. This is why we look at medium-term inflation. And there, we have to find the right balance between acting too early, meaning that we could choke the recovery, or acting too late, which could lead to high inflation becoming entrenched, which would also have a substantial cost. And we know that a recession, which can happen in both cases – whether you act too early or too late –, would again be likely to hit those the hardest who have the lowest income to begin with, because these are typically the people who are most affected by an increase in unemployment.
Some ECB watchers noticed that Outright Monetary Transactions wasn't mentioned among the tools listed in the conclusions of your strategy review. Has OMT been retired due to lack of use or is it still a tool available to you in the toolbox?
OMT remains an instrument in our toolkit. The motivation behind OMT that the Governing Council had at the time is still valid: the need to counter fragmentation on the one hand and to have conditionality on the other hand in order to minimise risks related to moral hazard and to protect monetary dominance. Yet, one may ask the question whether the eligibility criteria of OMT are the right ones in all circumstances. We know that there has been reluctance to resort to an ESM programme due to the stigma effect. At the same time, we are seeing that with NextGenerationEU, one can have conditionality without strong stigma effects. I think this is a discussion that we may want to have at some point.
The ECB has spent much of the last decade trying to get inflation up to its target. The last time the ECB raised rates was in 2011, which was shortly before the eurozone sovereign debt crisis started. Do you think that that makes the ECB more cautious about raising rates this time and more worried about returning to that environment of ultra ultra low inflation?
One has to be a bit careful in comparing the two situations. Before the pandemic, the euro area was in a quite different situation, and the experience from that time was reflected in our monetary policy strategy review. This is also when we developed our forward guidance, which now protects us from acting too early. But at the same time, once inflation expectations are de-anchored, it can be very costly to re-anchor them. That is also shown by historical experience. This is precisely the reason why it is better to respond in a timely but gradual fashion, rather than being forced to act abruptly at some point in time, which could also have adverse effects on financial stability. If you have a very abrupt policy change, investors are not able to adjust their portfolios in a gradual fashion. I really think it's important that we find the proper balance here.
The ECB last year added a financial stability assessment into its monetary policy considerations, which is a change from how it worked previously. How do you think financial stability risks will feature in the current discussion?
There was an agreement that financial stability is a prerequisite for price stability. And while macroprudential policies are the first line of defence, they are not yet perfectly effective. This is why we decided to also consider financial stability considerations in our monetary policy decisions. Such additional considerations, like financial stability or inequality, enter into a monetary policy decision when it comes to assessing the side effects of our measures − that is in our proportionality analysis, where we are trying to see whether the benefits of our measures are higher than the costs and whether one tool may be preferable to another one. And financial stability certainly plays a role there.