Interview with Politico
Interview with Luis de Guindos, Vice-President of the ECB, conducted by Johanna Treeck on 3 November 2022
8 November 2022
Now that interest rates are approaching the neutral rate, can we expect smaller hikes going forward?
The neutral rate is a very interesting theoretical concept. But I don’t think it’s very helpful for policy prescription because it's unobservable and moves over time.
We will continue raising rates to a level that ensures inflation will come back into line with our definition of price stability. That level will depend on the data that we receive, the evolution of inflation, economic conditions, demand, and energy prices.
Being data-dependent is the best approach in times of very high uncertainty such as we are living through now. At our next meeting, we will base our decision on the new projections that will be released in December and Eurostat’s flash inflation estimate for November, among other indicators.
Especially in light of this uncertainty would more incremental rate increases not be more prudent?
We are mainly guided by inflation and if you look at its evolution in October, you can see it is accelerating. Core inflation rose to 5%.
In December we will have new projections about the future evolution of inflation. I think we have been underestimating inflation for a long time, which is why it's important to have a much better understanding of inflation dynamics.
Do you expect to see a sizeable revision to the inflation outlook in December?
As I have said before, our projections will be published in December. My opinion is that inflation will hover around its present level of 10.7% over the next few months. It will start to decline in the first half of next year, but, on average, headline and core inflation will remain very high.
If you say very high, does that mean higher than the 5.5% the ECB currently projects for next year?
It is more about the trend, rather than a decimal point. I think the trend will be downwards in the first half of next year, even if still high on average.
We have all been underestimating inflation dynamics. Energy prices have had a lot to do with the evolution of inflation. By looking at the trajectory of energy prices, we can explain an important part of the evolution of headline inflation.
But beyond that, energy also indirectly influences other items in the basket of goods and services, which are the main components of the current core inflation. We might have underestimated this as well, and we need to understand it better.
We understand that some of your colleagues think markets may have interpreted President Christine Lagarde’s press conference as more dovish than was intended. Do you share this assessment?
The President’s press conference reflected the discussions and the debate that we had in the Governing Council. I think our communication was clear. Afterwards, you have interpretations and market reactions and, in the short term, markets sometimes overreact. However, I think a sort of correction followed the initial immediate reaction.
Can you give me a sense of how deep a recession you expect to see next year in the eurozone?
In our September projections it was only the downside scenario which included a recession, not the baseline. Since then, the data that we have received have not been good in terms of growth.
In my view, there is a high probability that quarterly growth in the fourth quarter of this year will be negative. Negative quarter-on-quarter growth is likely to continue in the first quarter of 2023, which means we would face a technical recession. However, I don’t think it is going to be very profound.
So you would expect a technical recession and then a rebound, starting from the second quarter?
This is something we will have to continue analysing. Leading indicators such as PMIs are pointing to negative growth in the fourth quarter, and again in the first quarter. After that, we would expect a recovery but, given the high level of uncertainty, predicting beyond six months becomes extremely difficult.
Where do you expect growth impulses to come from other than an end to the war in Ukraine?
The war is an exogenous factor for us. I hope that this unjustified invasion ends as soon as possible because of the human cost. In my view, the factors that will drive the recession are the energy shock and the deterioration of the terms of trade due to rising energy and commodity prices. According to our calculations, this deterioration could represent close to 3% of euro area GDP, which implies an impoverishment for everybody.
On top of this, current inflation is significantly reducing households’ real disposable income and negatively affecting capital expenditure. When you have inflation at the level that we have now, all the signals from the markets start to blur and capital allocation becomes much more difficult.
In this context, I think that the best contribution that a central bank can make towards restoring future growth is to reduce inflation.
Is the reason for a return to growth in the latter part of 2023 that there is lower inflation and so this uncertainty dissipates?
It’s not the only reason, but it is a very important one. The economic slowdown, including a possible technical recession, is driven by several factors: energy prices, uncertainty because of the war, and the dampening effect of inflation on investment and on household consumption through cuts in real disposable incomes.
In conclusion, if we want to improve the growth outlook, it is very important to tackle inflation.
So, it's not a trade-off between growth and inflation?
No, this time it is not a trade-off. The factors behind high inflation are the same as those behind the slowing down of the economy. In my view, this is why errors have been made and many models have failed. Because they are unable to capture the nature of the shock that we are suffering now.
Do you have a message for national leaders, including Emmanuel Macron and Georgia Meloni, who encouraged you to slow down tightening moves given the risks they pose to growth?
I respect the opinions of politicians and they are fully entitled to speak their minds. But our approach is quite clear: we have to abide by our mandate, which is price stability. We have to do our job and we have to explain what we are doing and why we need to tackle inflation, which is not an easy fight. For this, we are going to increase interest rates, which is going to have an impact on financing conditions. It will reduce aggregate demand, both consumption and investment, but it’s the only possible way forward that we have because doing nothing would be much worse.
The Finnish Prime Minister, Sanna Marin said in a tweet “there is something seriously wrong with the prevailing ideas of monetary policy when central banks protect their credibility by driving economies into recession.” Do you think that we need to have a debate about monetary policy ideas and if so, how can we do that without undermining your credibility in the process?
I will not enter into any political debate. One of the main reasons for the slowdown, including the technical recession we might face over the next quarters, is inflation. So reducing inflation is one of the main contributions that we can make in order to improve the growth outlook in the short to medium term.
If we do not reduce inflation, the situation will be much worse. This is why the majority of central banks are raising rates. In the euro area, we are starting from a very accommodative monetary policy that we are now in the process of normalising in line with our mandate to keep prices stable.
You said you underestimated the impact that imported inflation had on other prices. What about wage developments and inflation expectations? What do you make of the latest wage rounds and do you have a message for unions across the region?
I will not try to convey a message to unions. In the current context of an energy shock and a deterioration of the terms of trade, we are suffering an impoverishment of our society. But it’s important that conflicting claims from workers and companies don’t lead to a sequencing of increases in wages and margins that are not compatible with this new situation. Otherwise this could give rise to a spiral of wages and prices, which would harden the monetary policy reaction, leading to a much worse situation than the one we have now. This is something we should avoid.
In this context, fiscal policy can alleviate this impoverishment using very tailor-made policies for those parts of society that are much more vulnerable to the kind of shock that we are suffering.
Do you think that the current fiscal policies are targeted enough?
Last week we had the report of the European Fiscal Board, which states that most of the fiscal measures taken by governments are not targeted enough.
So you would like them to be more targeted than they currently are?
They have to be tailor-made to alleviate the hardships of the current shock. Fiscal policy has to react, supporting the incomes of the vulnerable groups of society. We should not fully eliminate the price signal, which could affect the compatibility between fiscal and monetary policy and delay the green transition. When we talk about targeted, selective measures, we are referring to support for the most vulnerable people.
How much of a problem is fiscal largess for the ECB right now?
I would wait for the European Commission to make an assessment on that. But my general recommendation is that fiscal policy cannot follow the stance that it did during the pandemic. This is because the nature of that shock was different. It required an extremely accommodative monetary policy that we are now normalising. Therefore, the general stance of fiscal policy has to be different too.
When do you think you will start quantitative tightening? Could it be quite soon?
We will start with it sooner or later, for sure in 2023. This process will have two positive effects: it will reduce excess liquidity and alleviate collateral scarcity. But quantitative tightening (QT) must be implemented with a lot of prudence. In my view, we should start with a passive QT by not fully reinvesting the maturing securities in our portfolio.
The characteristics and the timing of our QT, which may overlap or not with the process of normalising the interest rates, will be discussed in December. Personally, I don’t see any sort of sequencing here. The first instrument that we have used, because we believe it to be the most efficient one, is interest rates. QT is also part of the normalisation process of monetary policy and we will proceed with a lot of prudence and caution.
Still there are concerns that once you start reducing your balance sheet this could have a major impact on financial markets. And is the ECB currently facing a trade-off between price stability and financial stability?
Financial stability has deteriorated quite a lot over the last six months because of the economic outlook of lower growth and high inflation and the tightening of financial conditions.
However, the situation of the banks is much more positive now than it was ten years ago. They are more resilient today to that worsening of the outlook and the tightening of financial conditions. But we should pay special attention to non-bank financial institutions that are less strictly supervised and for which the macroprudential toolkit is more limited.
These institutions have taken a lot of risk in terms of leverage and illiquid assets in their portfolios. Although we don’t have any sort of supervisory power over them, we are very attentive to these institutions as they play a very important role in the financial landscape of the euro area and could potentially create a market accident. It would be very important to improve and enhance the macroprudential toolkit for non-banks to minimise potential risks.