Interview with Le Monde
Interview with Luis de Guindos, Vice-President of the ECB, conducted by Éric Albert on 15 December and published on 22 December
22 December 2022
What is your assessment of the euro area economy at the moment? Are we in a recession?
The indication for the fourth quarter of 2022 is that we are perhaps in negative territory, but not very deep, with GDP expected to contract by 0.2%. The lead indicators we have are not good. Our projections therefore expect the euro area to fall into a mild recession in the last quarter of this year and in the first quarter of 2023, when GDP is expected to contract by 0.1%.
On that basis, why is the ECB tightening its monetary policy? On Thursday, 15 December you raised the deposit facility rate by 50 basis points to 2%, while ECB President Christine Lagarde announced at the press conference that there would be several further rate increases in 2023. Don’t you risk making the recession worse?
Look at our inflation projections. We published our projections in September then again in December. The change in our growth projections between the two is not big: they are slightly better than expected for 2022 (revised up from 3.1% to 3.4%), slightly lower for 2023 (revised down from 0.9% to 0.5%) and identical for 2024 (1.9%). But the substantial change concerns inflation, which has been revised up quite significantly (from 5.5% to 6.3% for 2023 and from 2.3% to 3.4% for 2024).
That’s true, but inflation appears to have peaked. In the euro area, it fell from 10.6% in October to 10.1% in November. With commodity prices falling, this trend should continue.
We think that over the course of the next two or three months inflation will be somewhere around its current level, then in the second quarter of next year it will see a drop to hover around 7% by the middle of the year. But that is still clearly above our price stability target, i.e. inflation of 2% over the medium term. We have no choice but to act.
But in acting you are stifling what little growth remains…
Monetary policy works by tempering demand, which in turn tempers growth, there is no alternative. If we do nothing, the situation would be worse because inflation is one of the factors behind the current recession. It reduces households’ disposable income and affects the most vulnerable members of society in particular. By reducing inflation, we’ll contribute to growth.
How far should the ECB go in raising interest rates? President Lagarde clearly stated on 15 December that the ECB intends to raise interest rates by 50 basis points at the next meeting and perhaps by another 50 basis points at the meeting after that and possibly again at the next meeting after that, which would bring the deposit facility rate to 3.5%. Is that correct?
First, increases of 50 basis points may become the new norm in the near term. Second, we should expect to raise interest rates at this pace for a period of time. And third, our interest rates will then enter into restrictive territory. The steps we have taken so far are going to have an impact on inflation, but we still need to do more.
Wages are catching up, and I think that’s normal. Is it a wage-price spiral? Not at the moment. But it is very important that we don’t lose our credibility, that’s to say that inflation expectations do not start to become de-anchored. If households start thinking that the ECB is not doing enough, and they expect inflation to be 7% or 8% over the next three years, they would then ask for a pay increase of 7% or 8%, triggering the spiral. This would mean that we would have lost our credibility.
In the 1970s one of the reasons for the spiral was that wages were indexed to inflation. That’s practically no longer the case today, except in Belgium. Isn’t the situation completely different?
In the case of Belgium, and in the case of Luxembourg, indexation remains almost automatic. And if you look at Spain, figures from the Banco de España show that 25% of new wage agreements are now indexed to inflation. A year ago there were hardly any, so it’s a rising trend.
In raising interest rates, which slows the economy, you are going to make quite a few governments unhappy. Is this a test of your independence?
The best way to help governments is to reduce inflation. It is currently the main problem for many European countries. Admittedly, raising interest rates means an increase in funding costs for governments. But we have a mandate and we have to stick to it: inflation is currently at 10% and core inflation at 5%, whereas our target is 2%.
So you have no choice?
We have no choice, and I think not having the possibility to deviate from the target is a good thing. Because if we don’t control inflation, if we do not put inflation on a convergence trajectory towards 2%, it will be impossible for the economy to rebound.
You are also responsible for monitoring financial stability. What are you concerned about?
Financial stability conditions have deteriorated because of lower growth, higher inflation and the tightening of financial conditions. I am concerned that markets could underestimate the persistence of inflation. Euro area inflation has decreased from 10.6% to 10.1%, but that is not enough.
Furthermore, I am concerned that markets might consider fiscal policy to be incompatible with monetary policy, that there is a potential conflict. This is what happened in the United Kingdom in September. Finally, banks have a solid capital position and can withstand a shock. But I have a lot more doubts about non-banks, notably hedge funds. Their level of leverage is huge, they have highly illiquid assets and they have been accumulating risky assets. So an abrupt increase in rates could cause problems.