Interview with Delfi
Interview with Christine Lagarde, President of the ECB, conducted by Žanete Hāka
1 November 2022
Inflation is still far too high in the euro area as a whole, and especially in Latvia. As you know, inflation in Latvia stood at 21.8% in October, which is well above the euro area average of 10.7%. Higher energy and food prices are still the main drivers of price increases. We are increasingly seeing that these higher energy costs are feeding through to more and more sectors in the economy. With this in mind, last week we decided to raise our interest rates for the third time in a row. And we expect to raise interest rates further to make sure that inflation returns to our medium-term target of 2% in a timely manner.
Currently, the dominant view is that inflation will return closer to the 2% target in 2024 (ECB's forecast of 2.3% in 2024). Is this outlook realistic, or could it take longer to tame high prices? Some economists say that the ECB has been sluggish in responding to inflation since it started its steady upward journey in the summer of 2021.
We started normalising our monetary policy almost a year ago, in December 2021, when we announced that we would phase out net bond-buying under our pandemic emergency purchase programme. We followed up by ending net buying under our asset purchase programme and ending our forward guidance on interest rates. Since July we have raised interest rates by 200 basis points – the fastest increase in the history of the euro. But we are not done yet. We will decide on future policy steps meeting by meeting, each time assessing how the outlook for the economy and inflation has evolved, also considering how the measures we have taken so far are working. The longer inflation stays at such high levels, the greater the risk that it spreads throughout the economy. Consumers and companies would then also start to expect higher inflation rates in future, and that is dangerous. That is something we must avoid. And this is why we are determined to do what is necessary to bring inflation back to our 2% target.
How would you respond to critics who say that the ECB might be too aggressive with its current rate increases? The ECB’s main goal is to steady inflation, but are you not afraid that raising interest rates too high, too quickly could really hurt businesses and halt future growth?
It is true that the likelihood of a recession has increased and uncertainty remains high. In these circumstances, we all have to do our job. A central bank has to focus on its mandate. Our mandate is price stability, and we have to deliver on that using all the tools we have available, choosing those that will be most appropriate and efficient. Ultimately, persistently high inflation rates are more damaging to society because they make everybody poorer. Stable prices provide the foundation for a well-functioning economy in which everybody benefits.
What can we expect in future – is there a specific interest rate level that you think you will need to achieve to control the situation in the euro area economy? Or are there levels that you will not try to reach? Or will it depend on the economic situation? Will you look only at inflation, or at other factors as well?
We are aiming for the interest rate that will deliver the 2% medium-term inflation target. The destination is clear, and we are not there yet. We will have further rate increases in the future. I’m not going to give you a number because we have turned our back on forward guidance in the current highly uncertain environment. We will decide on the future path and the pace of our rate increases on a meeting-by-meeting basis.
Do you think that risks to financial stability or the housing market are also increasing at the moment? What should be done to reduce them, and what actions is the ECB taking in this regard?
The high rates of inflation that we are currently seeing are weighing on households’ disposable income, especially for those households whose income was low in the first place. At the same time, we see that the labour market is remarkably robust. This has helped to shore up household finances so far, together with savings built up during the pandemic, government support and loan repayment holidays. However, households might be vulnerable to increasing debt servicing costs, especially in countries where residential properties are overvalued, debt levels are elevated, and a larger share of household debt is subject to variable interest rates. These risks are best addressed by country-specific policies. We will provide a more detailed picture later this month when we publish our biannual Financial Stability Review.
Do you have any guidelines for banks in the event that the number of overdue loans increases rapidly to ensure financial stability?
Higher interest rates and the normalisation of monetary policy in general will affect banks differently depending on their business model. Our banking supervisors will make sure that banks are prepared to withstand potential adverse effects. But we all need to pay close attention to newly emerging risks, including those resulting from Russia’s war of aggression in Ukraine. The direct impact of the war on euro area banks has been limited so far, but the environment for businesses and the economy as a whole has changed. ECB banking supervisors have launched a review of the provisioning practices of the euro area’s most significant banks to ensure that they are prepared. We all need to be extremely vigilant right now.
Some people compare this crisis with the 2008 crisis; some say that they have nothing in common, but others find similarities. Do you think that the situation could become as bad as in 2008-09 or are central banks, countries and other institutions better prepared now?
We learned a great deal from the global financial crisis and banks are in a better position now than they were before that crisis. This is also because we now have joint banking supervision across the euro area. But there is no room for complacency. We all need to be vigilant and ready to respond to whatever may happen.
How do you evaluate the euro area countries’ financial discipline? In the pandemic, there was a need to increase countries’ debts and to support companies and households, but we are now facing an energy crisis and countries can’t reduce their debts, and payments for debts are increasing – is there a risk that countries could face a more severe crisis as a result?
Since Russia’s unjustifiable invasion of Ukraine, governments have acted quickly to help those most exposed to rising prices in the unfolding energy crisis. This is very encouraging as it strengthens our societies. But it is important that these measures are temporary, targeted and tailored, and they must also incentivise energy saving. Because only then will they help prevent the effects of high inflation from spreading throughout the economy and limit the impact on public finances. And beyond these emergency measures, it is essential that we accelerate the transition to clean energy. The EU can play a strong role here through public investments. This will then also lower inflationary pressures.
Latvia’s government debt stood at 41.6% of its overall economic output, or gross domestic product, at the end of the second quarter of this year. This is far below the euro area average of 94.2%. One of the biggest risks I see, not only for Latvia but for the entire euro area, is the high level of uncertainty that we are facing as a result of Russia’s war in Ukraine. Large parts of inflation are being driven by higher energy costs. The limited visibility on how these will develop makes it hard for households and companies to plan ahead. A coordinated EU response to provide energy supply security could change this, for example though common EU purchases. It would avoid EU countries outbidding each other on the international energy market.
We published our latest round of projections in September. The baseline projections showed inflation at 8.1% this year, 5.5% next year and 2.3% in 2024. Growth is expected to slow to 0.9% next year and to reach 1.9% in 2024. Given the high level of uncertainty about the economic outlook for the euro area owing to Russia’s war in Ukraine, we also published a downside scenario that assumes that the war is very protracted, implying persistent geopolitical tensions. The downside scenario foresees slightly higher inflation rates for this year and next, reaching 2.7% in 2024. While this scenario still expects the euro area economy to grow this year, it foresees a contraction next year, and a return to growth in 2024. Since September, the growth outlook compared with the baseline has weakened. We will have a more complete picture in December when we have our next round of projections.