Interview with Bloomberg
Interview with Luis de Guindos, Vice-President of the ECB, conducted by Jana Randow and Alessandra Migliaccio on 20 April 2022
21 April 2022
Inflation rates are climbing, economic risks are increasing. What is a realistic scenario for the euro area economy at the moment?
Before the invasion of Ukraine, the economy was recovering. Our prediction was for growth of a little more than 4% this year, and an inflation rate that was clearly on the rise. We had underestimated inflation for a period of time. And now there’s the impact of the war. The consequences for inflation are quite clear. Inflation is accelerating because of energy prices, commodity prices and supply bottlenecks. But simultaneously we’re seeing a reduction in growth through a deterioration of trade. The message is crystal clear in this respect – we’ll see higher inflation and lower growth. That should be reflected in our June outlook.
Will we reach a situation of stagflation?
It depends on the definition of stagflation. If we define it as negative growth year-on-year with very high inflation, then even in the severe scenario, we do not see stagflation.
Will we see a recession in the euro area?
A technical recession – two quarters in a row of negative growth –, is not currently part of our projections. We’ll have an update in June. There is a clear deterioration in the economic environment. But that was included in our severe scenario. The growth rate of the European economy will be very low in the first half of the year. But I don’t believe it will go into negative territory in this first half.
Is the severe case in the ECB’s March projections where the economy is heading?
There is a lot of uncertainty now. You can always imagine worse scenarios, but we have to be realistic. We do not see negative growth year-on-year, but inflation is going to be high for the rest of the year. We believe we are getting closer to the peak. Inflation will start to decline in the second half of the year. But even so, it will be above 4% in the final quarter.
We also need to acknowledge that the level of uncertainty is huge. There are a lot of variables that we cannot control, that are exogenous factors that could affect the evolution of the economy for better or for worse.
Will inflation approach the ECB’s 2% medium-term target from above or below?
We will have our projections and different scenarios in June. If you look at survey and market-based inflation expectations, they are around 2% in the medium term. Some slightly above that, some very close to it. What’s clear is that in the medium term, inflation will be much closer to our definition of price stability.
At your meeting last week, some Governing Council members were pushing for an earlier end to net bond-buying. When do you think the asset purchase programme (APP) should end?
We were clear that we are going to end the APP in the third quarter of this year. Whether it happens at the start or the end is essentially fine-tuning monetary policy and in my view it’s not such a determinant factor per se. Having said that, at the moment I see no reason why we should not discontinue our APP programme in July.
If the APP ends in July, is a rate increase possible in July as well?
Theoretically everything is possible. But we need to keep in mind that we have now clearly delinked the end of the APP to the first rate hike, so a rate hike doesn’t need to come automatically once the APP ends. We can have some time in between and we are data-dependent. My opinion is that the programme should end in July and for the first rate hike we will have to see our projections, the different scenarios and, only then, decide. And nothing has been decided so far.
Again, can liftoff happen already in July?
It will depend on the data we see in June. From today’s perspective, July is possible and September, or later, is also possible. We will look at the data and only then decide.
Where do you see rates moving after liftoff?
Our rate-hike cycle will depend on the data. We will act depending on the evolution of inflation. We don’t face any restrictions in that respect.
Inflation expectations and second-round effects are the main factors to look at when setting monetary policy. Two-thirds of the inflation we are suffering now is due to energy prices, so it’s imported inflation. Monetary policy can do very little to deal with this kind of inflation. The main risk is that this type of inflation starts to be more and more persistent and gives rise to second-round effects. We need to monitor this very, very closely.
The longer inflation remains high, the higher the possibility of having wage indexation clauses in the collective bargaining process. We have not seen much in terms of wage increases so far in Europe. But if we start to observe a de-anchoring of inflation expectations and second-round effects, then this is going to be a key element for the future of monetary policy. The Governing Council looks at these data at every meeting.
Is there a clear understanding at the ECB about where the neutral policy rate has settled?
It’s very difficult to gauge unobservable variables. That’s true for potential growth, output gaps and also the natural rate of interest. The natural rate has been declining over the last two decades owing to structural factors such as demographics, globalisation and digitalisation. But the world is now changing. I cannot give you a figure, I don’t believe anyone can. But I think that the natural rate now is clearly on the rise.
One of the consequences of this terrible war is that the dividend of peace we’ve benefited from over these years is possibly fading away. Governments may want to spend on other things, like the military and defence. That will change fiscal policy and it is not trivial in terms of potential growth in the medium term.
With the APP about to end, are you concerned about fragmentation in financial markets?
Fragmentation risks aren’t a new concern, and we addressed them when we integrated flexibility into the pandemic emergency purchase programme (PEPP). Fragmentation undermines the proper transmission of monetary policy. At the same time, any decision taken to limit fragmentation should not interfere with our monetary policy stance. We conduct monetary policy to maintain price stability. Mixing monetary policy with addressing fragmentation would be a mistake, and the Governing Council is aware of that. We’d like to avoid fragmentation that is not idiosyncratic, that is exogenous. We have some instruments to address this kind of problem. So far, in the Governing Council, we have not discussed any new anti-fragmentation programme in detail.
The main source of potential fragmentation has to do with divergences of countries’ fiscal profiles and potential growth. Monetary policy can do something, but to minimise the potential risk of fragmentation fiscal sustainability in the long term and structural reforms that enhance productivity and competitiveness are needed.
Do you see any problems with the ECB’s preference to end bond-buying before raising rates should asset purchases be needed to address fragmentation in the future?
The nature of the APP is different from the PEPP. That was quite clear from the very beginning. The APP is designed to deliver price stability, not to deal with fragmentation. The PEPP, on the other hand, has a certain flexibility embedded in it. So you have one instrument to adjust the monetary policy stance and another one to respond to exogenous fragmentation. The latter should not interfere with the monetary policy stance. Sequencing is not relevant here.
Energy traders have turned to the ECB for help, and some parts of the market have struggled with the implications of the war. Do you see anything that concerns you in terms of financial stability?
The consequences of the war in terms of financial stability have been much more contained than the situation we had at the beginning of the pandemic. In terms of liquidity, in terms of market tension, it’s not comparable. We have seen some signs of stress in commodity derivatives´ markets, but so far all obligations have been honoured. And in terms of liquidity facilities, our counterparties are banks. We have a very clear framework with respect to central bank liquidity facilities.
Let’s talk about fiscal policy and structural reforms. Is what you’re seeing at the moment enough to deal with Europe’s challenges ahead?
Before the invasion of Ukraine there was a deterioration in public debt ratios in the euro area because of the pandemic, which on average rose by almost 20 percentage points of GDP. But in economics, as in life in general, it’s not only the average that matters and not all countries are in an identical situation. Fiscal policy to address the consequences of the invasion must be different from what we saw during the pandemic. It has a role to play for sure, but it needs to be much more targeted and selective.
Should governments consider funding investments in energy independence or military spending jointly and in a similar fashion to what we’ve seen after the pandemic?
This is a political decision. We are in a change of paradigm. The geopolitical situation has changed and governments are taking decisions in that respect. They will increase military expenditure and try to accelerate the energy transition to reduce dependence on Russia. I have always been in favour of a centralised fiscal capacity. It could make sense now, but it is for the European Council to make a decision about that.
How much of a difference would such a decision make in financial markets when it comes to sovereign yields?
We have not seen fragmentation in financial markets so far. We have seen a little widening of spreads for Italy, Spain or Portugal. But this is not fragmentation like we had in 2010-2012. It’s totally different. And that’s despite the fact that we’re normalising monetary policy. We’ve seen some upward moves mostly at the end of the yield curve, but fragmentation has been contained.