Interview with Handelsblatt
Interview with Luis de Guindos, Vice-President of the ECB, conducted by Frank Wiebe and Jan Mallien on 14 March
20 March 2022
Mr de Guindos, how big is the danger that the war in Ukraine will cause problems in the European financial system?
Some risks, such as the high financial market valuations and public and private indebtedness, were present even before the current crisis. But the situation today is not comparable to the one we had two years ago when the coronavirus (COVID-19) pandemic broke out. There are no liquidity bottlenecks. Firms can still issue bonds, for example. Stock markets are indeed fluctuating but for the moment we are not seeing any dramatic developments.
But haven’t there been problems in the commodities markets?
Margin calls on commodities derivatives have been triggered, in other words, there have been demands for further collateral to cover open positions. But according to our observations, those facing these margin calls have so far been able to meet them.
What do you see as the greatest danger for the financial system?
The macro risk, that is to say the possible consequences for the overall economy; higher inflation and slower growth are the greatest risks, for the banks too. That macro risk plays a far more important role than problems in individual market segments.
Are we now heading towards stagflation, a situation in which economic growth is weak and inflation is high?
I wouldn’t say so. Before the outbreak of the war we had assumed a growth rate of 4% for this year and a little bit less for next year respectively. In the most recent projections, even in our most adverse scenario for the current year, we still foresee growth of more than 2%, so no stagflation. Inflation, however, is likely to remain higher for a longer period than expected before the war.
The euro has been weak recently. What role does that play?
We do not target a particular exchange rate. We are of course aware that a weaker euro exchange rate will make certain imports more expensive. On the other hand, the currency movement is most visible against the US dollar, which is still in demand as a safe-haven currency. If we focus on the basket of currencies of our trading partners, we see that the euro has remained quite stable.
There is even some speculation that the ECB might intervene in the foreign exchange market.
We aren’t intervening in the foreign exchange market because we don’t target any exchange rate.
Inflation has recently increased considerably. Is the ECB still actually able to keep prices under control?
What matters for us now is the extent to which wages respond. Because if wage increases are too high, they can push prices up even more and contribute to persistently higher inflation. We have not seen any signs of that yet, but we need to monitor developments closely. The same goes for inflation expectations. On the basis of survey information and market data, expectations for the next three to five years are anchored close to our inflation target of 2%. But we need to keep a close watch on that.
The ECB last week held out the prospect of a more rapid end to its bond purchases. What does that mean for potential interest rate hikes?
The most important decision taken during our meeting was to delink the potential interest rate hikes from the asset purchase programme; interest rates will not need to be increased automatically after the end of net asset purchases. In this way we are keeping all our options open to respond flexibly to the data.
Does that mean the first interest rate rise will only come later?
It all depends on the data. We are monitoring developments in inflation very closely. We will be extremely vigilant concerning second-round effects and we will be attentive to any developments that could indicate a wage-price spiral, where both factors become mutually reinforcing. Fiscal policy should also play a role here.
What exactly do you mean?
The price shock in energy and commodities that we’re currently experiencing is making many firms and workers worse off. Fiscal policy should provide temporary, targeted support to help reduce the burden. This would also reduce the danger of a wage-price spiral.
Do last week’s decisions actually amount to a tightening of monetary policy?
I would say it’s a normalisation.
According to the ECB’s projections, inflation should fall back to 2% again in 2024. Why would that happen so fast?
At the moment making projections is particularly difficult. One reason for the drop in inflation could be that the significant increase in energy prices cannot last for too long. Prices can stabilise at a high level, but no longer increase at the current high rate.
The ECB repeatedly overestimated inflation in the past, whereas more recently it’s been underestimating inflation. Is there a problem with the models underlying the projections?
Over the past year we have underestimated inflation, as other institutions and economists have too. Forecasting is particularly challenging in periods of high uncertainty. Past trends play an important role in the models. Models have a tendency that projected inflation levels revert to the historical mean.
But what will the ECB do if it continues to underestimate inflation?
Our decisions are based on the data. If we continue to underestimate inflation, we will respond. All options are on the table. Second round effects and a potential de-anchoring of medium-term inflation expectations will be the deciding factors. If we see those, then we will act.
In Germany there’s great concern that the ECB can’t steer hard away from inflation because of the high indebtedness of countries like Italy and Spain.
Our monetary policy is wholly determined by our price stability mandate. Our monetary policy decisions and the available instruments are geared to meeting our inflation target.
A fragmentation of the euro area, with for instance major divergence in interest rates in the bond markets, could undermine the effect of monetary policy. However, the risk premia on these countries’ government bonds are about the same now as they were before the pandemic. They remain clearly below the highs seen around 2011 and 2014. In addition, nominal yields are still very low overall.
Nonetheless, in the past weaknesses in the construction of the euro area have emerged again and again. Are the ECB’s instruments adequate to keep these risk premia in check if they start increasing once more?
We have the possibility to counteract that in a targeted way through reinvesting in a flexible way the purchases to replace maturing bonds under the pandemic emergency purchase programme (PEPP). But we have to make a clear distinction between this flexibility and our general monetary policy objective. Our task is price stability.
Isn’t keeping the euro area together a task for fiscal policy?
There’s no doubt that fiscal policy has an important job to do. It needs to tackle, in a targeted way, the hardships resulting from the current crisis. A targeted and temporary approach is also important to prevent the amounts of support involved from driving government debt substantially higher.
Where should that be done, at the national or the European level?
Initially at the national level, but a coordination framework should be agreed at European level.