Interview with Reuters
Interview with Isabel Schnabel, Member of the Executive Board of the ECB, conducted by Balazs Koranyi and Frank Siebelt on 16 August 2022
18 August 2022
Please give us your assessment of growth and inflation developments since your last policy meeting.
The euro area economy is clearly slowing. Some of the downside risks that we identified in June are now materialising. Indicators like consumer or business confidence have declined further. The Purchasing Managers' Indices (PMIs) have dropped notably, not only in manufacturing but also in services.
On the other hand, we had a relatively good second quarter, which shows that some pockets of resilience are supporting economic growth. Where is this resilience? One source is pent-up demand, which shows up particularly in services; tourism has probably been especially strong. This is likely going to carry over into the third quarter but it may fade towards the end of the year.
We also have a very strong labour market. We see continued acute shortages of labour, historically low unemployment and a high number of vacancies. This probably implies that even if we enter a downturn, firms may be quite reluctant to shed workers on a broad scale. This will support household incomes. And finally, we have fiscal policy, which tries to compensate, at least in part, for the decline in real household income.
Nevertheless, there is a strong indication that growth is going to slow and I would not rule out that we enter a technical recession, especially if energy supplies from Russia are disrupted further. Downside risks to economic growth have also increased due to additional supply-side shocks, caused by droughts or the low water levels in major rivers.
But there is country heterogeneity. It seems that, out of the larger euro area countries, Germany is hit the hardest.
During the pandemic, the economy adapted quite well to the new realities. Do you see scope for a similarly quick adjustment?
We have learned that the economy is able to adapt. But the energy price shock is too big to be fully offset.
If there is a recession, how persistent is it going to be?
I do not see any indication of a prolonged, deep recession at the moment. It’s not even clear that there's going to be a technical recession in the euro area at all. I would just not rule it out.
Where do you see inflation going and what are the implications of the persistent overshooting of inflation above expectations?
Headline inflation in the euro area increased again in July and now stands at 8.9%. Energy prices, particularly gas, and food prices are playing an important role. But it's much broader than that. We see high and increasing inflation rates in services and for non-energy industrial goods. It's a broad-based development. If you look at any of our measures of underlying inflation, they are moving up further and stand at historical highs.
These inflationary pressures are likely to be with us for some time; they won’t vanish quickly. Even with the ongoing monetary policy normalisation, it will take some time until inflation gets back to 2%.
But forecasting has proven quite hard in recent years and our staff are continuously working on improving the economic projections. There are some specific post-pandemic factors which we now try to take into account. For example, we have seen a relatively quick pass-through from energy prices and producer prices to consumer prices. We are also seeing an elevated level of refining margins.
Still, we have to be aware that any projection model will have a hard time dealing with fundamental structural shifts related to the pandemic, the war or the green transition. This speaks in favour of giving more weight to actual inflation outcomes in monetary policy decisions.
Where and when could inflation peak?
I would not exclude that, in the short run, inflation is going to increase further. But any projection is currently subject to high uncertainty. So it's very difficult to predict when inflation is going to peak.
What does it mean in practice that you should place greater emphasis on actual inflation in policy decisions?
Inflation projections play a key role in our monetary policy decisions. But we should not ignore what is happening at the moment. We have seen that our models have not been particularly good in projecting the future path of inflation. Therefore, current inflation outcomes provide additional, useful information.
Would higher inflation readings mean you need to raise your projections?
There are different factors at work. Economic growth, of course, has an impact on the inflation projection. Still, even if we entered a recession, it’s quite unlikely that inflationary pressures will abate by themselves. What we're seeing is a supply-side shock that is slowing growth and at the same time raising price pressures. The growth slowdown is then probably not sufficient to dampen inflation even if it reduces the price pressures due to slowing demand.
How will German government measures impact inflation?
In Germany it's relatively likely that inflation is going to move up further because some government measures that were used to fight inflation are going to be reversed or new measures introduced. These include the end of the nine-euro public transport ticket and of the fuel rebates, as well as the introduction of the natural gas levy.
Do you see a risk of inflation expectations getting de-anchored?
Most measures of longer-term inflation expectations remain around 2%. However, a number of indicators are pointing towards an elevated risk of de-anchoring. If you look at our household survey, the Consumer Expectations Survey, we can see that the median expectation of inflation three years ahead has edged up after having been anchored at 2% throughout the pandemic.
We also see an upward movement in the Survey of Professional Forecasters. This increase has been very gradual, but sustained.
And maybe most importantly, we see that the right tail of these distributions has shifted upwards, meaning that an increasing share of survey respondents expect inflation to be well above our target. This is sometimes seen as an early warning indicator of de-anchoring. I think it's very important that we take such signs seriously.
What are the implications of this assessment for the September policy meeting?
Our monetary policy decisions are guided by the inflation outlook. We are currently seeing very high inflation rates. Our latest projected inflation numbers were also quite high and the factors driving inflation are not disappearing anytime soon.
This is why in July we embarked on monetary policy normalisation, which has just started and which is going to continue. In July we decided to raise rates by 50 basis points because we were concerned about the inflation outlook. At the same time, we shifted to a meeting-by-meeting approach, which means that any decision is going to be taken on the basis of incoming data.
If I look at the most recent data, I would say that the concerns we had in July have not been alleviated. In September, we're going to have an assessment of all the available data and we're going to have new staff projections.
What would be your preference for September?
It's not about preference, it's about what is appropriate to bring inflation down to 2% over the medium term. In July we decided on a 50 basis point hike in light of the inflation outlook. At the moment I do not think this outlook has changed fundamentally.
Could the Transmission Protection Instrument (TPI) allow for larger rate hikes?
I would not put it that way. TPI is not an instrument for adjusting our monetary policy stance; it's an instrument that deals with risks to monetary policy transmission. So, I would like to separate the two things. We need to decide on the appropriate monetary policy stance in order to bring inflation down to 2% over the medium term. And then TPI ensures that this desired monetary policy stance is transmitted smoothly across the euro area.
Markets price about 110 basis points of rate hikes this year and a total of 145 basis points until the peak of the cycle. Are you comfortable with those expectations?
We have moved to a meeting-by-meeting approach, so we’ve moved away from giving any precise forward guidance on the future path of interest rates. The broad direction of policy is pretty clear, but we don’t want to give particular guidance due to the high level of uncertainty. Forward guidance still remains part of our toolkit. It is particularly beneficial when the economy is close to the effective lower bound. Then forward guidance allows for additional easing, even when one cannot lower interest rates further.
Where is the neutral rate and would that be enough to get inflation down or do you need to go into restrictive territory?
At this point in time, the level of the neutral rate is not the relevant question. Real short-term rates remain in deep negative territory, meaning we are quite far away from the point where our policy becomes restrictive. It is also not easy to operationalise the neutral rate in monetary policy decisions because estimates are surrounded by large uncertainty. I think it's a useful theoretical concept but in practical terms, it doesn't help us much.
This is something we haven’t discussed yet. We have followed our pre-announced sequencing, which stipulated that we were going to hike interest rates before ending reinvestments under the asset purchase programme (APP). But, of course, the size of our balance sheet is an integral part of our regular monetary policy stance discussions.
Could this be on the agenda for September?
I cannot tell you what my colleagues are going to say in the September meeting, but I wouldn't rule out someone bringing this up.
How does the weak euro figure into your calculus?
We do not comment on the level of the exchange rate. But persistent exchange rate movements matter for monetary policy because they have an impact on the inflation outlook. The euro has depreciated notably, particularly vis-à-vis the US dollar. This matters even more when facing an energy price shock, because a large share of euro area energy imports is invoiced in US dollars.
In the past ECB studies argued that the exchange rate pass-through to inflation has diminished over time. Could that be changing now?
I would argue that, in this particular situation of an energy supply shock, the exchange rate matters more.
PEPP reinvestments were skewed towards several southern European countries in June and July. Should we expect this trend to continue in August.
The reinvestment flexibility under the pandemic emergency purchase programme (PEPP) helps us counter fragmentation risks and risks to the transmission mechanism related to the pandemic. The use of this instrument, like that of any of our instruments, has to be proportionate. This implies that the activation of the tool is going to happen only to the extent necessary. At the beginning of the pandemic we saw that short intervention periods can be sufficient in order to stabilise markets.
Can you spell out the difference between the trigger for using PEPP reinvestment flexibly and the trigger for activating TPI?
I would frame it somewhat differently because these are different tools. The PEPP deals with risks to the transmission mechanism related to the pandemic. It is a temporary tool, which is important.
The other tool, TPI, is different in several respects. It is a permanent tool and the purchase volumes are not restricted ex ante. At the same time, it requires a broader assessment. In particular, it requires an assessment of various eligibility criteria related to compliance with the EU fiscal framework, macroeconomic imbalances, fiscal sustainability and sound macroeconomic policies.
The Governing Council has to decide which tool to use under which circumstances. It also has to check the relevant criteria for these tools. And importantly, it has to make sure that the use of the tools is proportionate.
Proportionality implies three things. We have to show that the tool is effective, i.e. that it serves its purpose. We have to demonstrate that the tool is efficient, so there is no other tool that can achieve the same objective at lower costs. And, finally, the potential benefits have to outweigh the potential costs or side effects.
Are any of these criteria must haves?
All of them are very important. In the end, the decision always rests with the Governing Council. But at the same time, we have to take these eligibility criteria very seriously to ensure that we remain firmly within our mandate and legal framework.
But failing one criterion does not automatically exclude the country and it's still ultimately the Governing Council's discretion?
It's the Governing Council's decision but all the criteria should be met.
Is there any country currently in the euro area that does not meet all the criteria?
Such an assessment would only take place at a time when the Governing Council considers it appropriate to activate the tool.
Do you see undue fragmentation in the market right now?
Markets are more stable today, but August is always an unusual period as many traders are on vacation. Volatility remains elevated and liquidity is low. We monitor markets carefully.
PEPP reinvestments are now deviating from the capital key. Is this a permanent deviation?
Capital key deviations are relatively small. Adjustments to our asset holdings would need to avoid any interference with the monetary policy stance and with the smooth transmission of monetary policy.
Do you plan to sterilise TPI purchases?
We announced that TPI purchases must not interfere with the monetary policy stance. That implies that we need to avoid any persistent effect on the Eurosystem’s balance sheet and on excess liquidity. There are different ways to do that. But so far we haven't been explicit about what we will do because this will be decided if and when the TPI is activated.