Interview with El País
Interview with Frank Elderson, Member of the Executive Board of the ECB and Vice-Chair of the Supervisory Board of the ECB, conducted by Lluís Pellicer
30 March 2023
You have said that euro area banks are safe. Are all the channels of financial crisis contagion closed?
The euro area banking system is sound and resilient: it has robust capital and liquidity levels. And we have implemented the post-crisis regulatory regime, with rigorous supervision. Moreover, the ECB stands ready and has the necessary tools available to provide liquidity to the system if needed. President Lagarde made it very clear: there is no trade-off between price stability and financial stability. We are not caught between a rock and a hard place, as our decision to raise interest rates by 50 basis points shows.
Things are still turbulent two weeks on from the start of the crisis. Do you think it will be necessary to use those tools?
As I said, the banks are resilient, they are well capitalised and they are well supervised.
Some people are drawing parallels between the Silicon Valley Bank (SVB) crisis and the Bear Stearns crisis in 2008. Could we be on the verge of another crisis like that one?
No, this situation is very different. There was a strong agenda of regulatory reforms in Europe after the great financial crisis. Those changes have been implemented and the banks are subject to Basel III and to European banking supervision. Besides, SVB had a very unusual business model, which was highly exposed to interest rate risk and had a highly concentrated deposit base. Among the banks supervised by the ECB, the business models that rely more on deposits are more diversified.
But some analysts believe that the abrupt interest rate hikes by central banks after an era of ultra-low rates are also behind the banking crises…
One thing is clear: inflation is too high and we have to bring it down. That is what has driven our monetary policy tightening. Financial stability is a precondition for achieving price stability, as it is necessary for the smooth transmission of monetary policy. But as I already said: we have instruments to cater for both aspects.
In the specific case of SVB, the bank was extremely exposed to interest rate adjustments, and its core business was highly concentrated. These characteristics are not as salient in euro area banks.
Could Switzerland’s decision to impose losses on holders of high-risk bonds before shareholders have consequences for the euro area banking system?
Euro area banks’ exposure to the high-risk Credit Suisse bonds that were wiped out is very limited. Moreover, in the European Union shareholders always absorb losses first – those high-risk instruments are only affected thereafter. This approach has been followed consistently and will continue to guide our actions in crisis cases, as we recently reiterated in a joint statement with the Single Resolution Board and the European Banking Authority.
At the last Governing Council meeting you decided to push ahead with your plan and raise interest rates to 3%. Would you have taken the same decision today?
At the last Governing Council meeting we agreed on an interest rate hike that had already been indicated in February. In view of the prevailing outlook, with inflation remaining far too high, that decision is as robust today as it was when we took it. That being said, it is true that, given the uncertain impact of recent market tensions on the inflation outlook, we didn’t indicate any specific intentions about future decisions, as we had done in the past. Instead, in our view it was best to be clear about our reaction function – that is, to explain the elements that we will consider in the future when taking decisions. There are three elements: the inflation outlook, based on our analysis of the incoming economic and financial data; the underlying inflation dynamics; and the strength of monetary policy transmission. In other words, we are not pre-empting the decisions we will take in the future, but we remain committed to ensuring that inflation returns to our 2% target in the medium term.
So you didn’t agree to raise rates by half a percentage point to avoid sending a pessimistic message to the markets?
We had already made it clear in February that this was our intention. At the time there was already a high degree of uncertainty owing to a number of factors: the aftermath of the pandemic, Russia’s illegal war in Ukraine and the ongoing climate and environmental crises. And now the financial market tensions come on top of that. However, it was clear that inflation was still far too high, and keeping it in check is our primary objective. That led us to deliver on our intention to raise interest rates by 50 basis points. The increased uncertainty also led us to give very clear guidance on our reaction function.
Before the Governing Council meeting, the Spanish Government called on you to be prudent in the light of the market tensions. Were you?
We need to deliver on our price stability objective. European citizens trust us to deliver on it, and we owe it to them. In our last meeting we sent a very strong signal of our commitment to this.
I am very aware of how difficult the current economic and financial circumstances make it for many people, also in Spain, to get to the end of the month. Since we started to raise rates, monthly payments on variable rate mortgages, which are very common in Spain, have increased by €400 on average. I understand how frustrating that is. But you have to differentiate between the illness, which is inflation, and the medicine, which is the interest rate hikes. A lot of medicine tastes bitter, but if you don’t take it, the illness gets worse. And in this case, if high inflation becomes entrenched, it will be the people who are already suffering the most that will end up paying the price.
That metaphor takes me back to ten years ago, when we were told that austerity was a pill we had to swallow in order to recover, but it ended up being harmful…
I understand what you are saying, but the best thing we can do is make sure that inflation returns to our 2% target as soon as possible. That is our task, and that is what we are committed to doing. So we have to go through this hiking phase. Besides, this situation is completely different from what happened over a decade ago. The ECB has been quick to act and had an accommodative policy stance that was crucial for navigating the effects of the pandemic. We are now in a different situation, one where high inflation is the biggest problem, and, again, we need to act.
ECB staff now see inflation averaging 2.1% in 2025, only ten basis points above the ECB’s target. Does this mean that the interest rate hikes will start to slow down?
Our latest projections, which were finalised in early March, foresee headline inflation at 2.1% towards the end of 2025 and core inflation a little higher, at 2.2%. These projections are based on technical assumptions with a cut-off date of 15 February and therefore do not take into account recent market developments. This is precisely why we wanted to make our reaction function clear – to show that we have to take decisions based on the incoming data. The data evolve, and our assessment along with them. That’s why we cannot pre-empt today any decision to be taken in May.
You have raised interest rates six times in nine months, from -0.5% to 3%. Are you not afraid of damaging the economy?
If it becomes entrenched, the high inflation we are experiencing in the euro area will inflict substantial damage on the economy and mainly affect the most disadvantaged. The ECB must counter it. That is our mandate. And our primary tool to fight inflation is interest rates. Restrictive monetary policy lowers inflation by removing excess aggregate demand. This leads to some economic slowdown in the short term, but in the medium and long term society as a whole benefits when inflation eases. Price stability is a precondition for sustainable growth.
How long are we going to be in restrictive territory, with monetary policy cooling the economy?
In line with the elements of our reaction function that I already mentioned, we will see how restrictive we need to be, and for how long, in order to achieve our inflation target. If – and this is a big “if” – the baseline scenario we discussed at our last meeting persists, there will still be more ground to cover and we will have to raise interest rates further. Those grounds to cover would not only depend on how market tensions evolve but also on underlying inflation convincingly turning the corner. But there is certainly additional uncertainty, so we cannot say with any precision how monetary policy will evolve from here.
In Spain, mortgage payments have risen quickly, but the same hasn’t happened with the remuneration of deposits. What would you say to the banks?
That is between the banks and their customers. Let me just say that, economically, it makes sense that when interest rates go up, the remuneration of deposits also ends up rising. This is part of monetary policy transmission. There can be lags, especially when there is still a lot of liquidity in the system, but it’s a logical consequence of raising rates.
Unidas Podemos – the smaller party in Spain’s coalition government – has suggested capping mortgage payments. Do you think that’s possible?
It’s not for me to comment on proposals from political parties. In general, while we understand why governments are implementing various measures, it’s important that these measures are temporary, targeted at those who really need them most, and tailored to the specific context. We have analysed all the government support measures across the euro area, and only 10% are targeted at low-income households. There are two important points here. First, you have to ensure that government finances remain sustainable. Second, the measures must be temporary and targeted because they could generate more inflationary pressures if these conditions aren’t met. And that would mean we would have to do more to fulfil our price stability objective.
Is it time for these measures to be withdrawn?
As energy prices come down, it’s important that European governments withdraw measures where possible.
This month you have also started shrinking your balance sheet – at a pace of €15 billion per month until June. Might you slow down, given the financial tensions?
Interest rates are currently the main instrument we adjust in the pursuit of our price stability mandate, guided by our reaction function. Complementing that, we will continue to shrink our bond portfolio in a balanced manner.
Spreads have remained under control so far. Do you anticipate the current turbulence starting to affect the debt of the peripheral countries, like Spain and Italy?
We are not seeing any movements in the bond markets that give us cause for concern. If there are tensions in the future, we have all our instruments at our disposal. This includes the Transmission Protection Instrument (TPI), which would allow us to counter the risks of fragmentation that could threaten the transmission of our monetary policy to all euro area countries.
Has using the TPI been discussed in any meetings?
That hasn’t been necessary. But we have the necessary elements in place to ensure the smooth transmission of our monetary policy.
The energy crisis has highlighted the need to speed up the energy transition. How can a central bank contribute to this objective?
We have actually just disclosed the carbon footprint of the ECB’s balance sheet and of the Eurosystem’s corporate sector holdings, which we are gradually decarbonising on a path that is aligned with the goals of the Paris Agreement. We have also taken measures relating to our collateral framework and to our risk assessment and management tools. Additionally, our objective as banking supervisors is to ensure that banks manage all their climate-related and environmental risks effectively, and for them to be resilient in an economy that needs to pick up the pace towards net zero emissions. To achieve this, we have set out a multi-year plan to ensure that the banks meet our expectations. And we have committed to doing more, if necessary and within our mandate, to ensure we continue to support the goals of the Paris Agreement.
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