Interview with Cyprus News Agency

Interview with Philip R. Lane, Member of the Executive Board of the ECB, conducted by Gregory Savva on 5 April

6 April 2023

We’ve seen some recent banking failures in regional banks in the United States, which − along with the turmoil caused by Credit Suisse − have created some concerns for depositors and investors alike. Do you think there is a risk of these limited shocks turning into something systemic?

I think it’s important for everyone to understand the differences between the euro area, Switzerland and the US banking system. In the euro area we’ve had a very significant focus on making sure that the banks have high capital and liquidity ratios, that they are supervised in a strict way by the European Central Bank. For these reasons − and also because we see that the European economy is performing relatively well and is expected to grow by around 1% this year − and under these conditions, of course, we look carefully, but our assessment is that the euro area banking system is strong, it’s stable, and it is not as vulnerable as some of the banks you mentioned to changes in interest rates, to changes in the economy. So while we are always on guard, I think that everyone should understand the euro area banking system is in good shape.

So you believe that there are no similarities between what happened in the United States and the European banking system?

Let me emphasise that we are always looking closely and with great attention. But, because of the strict supervision, because European supervisors were on guard about the implications of rising interest rates for banks, it’s becoming increasingly clear that investors appreciate that the European banking system has prepared for the situation we face of rising interest rates, and that these risks are well contained. For this reason we should be confident about the state of the European banking system.

So do you think that there is no problem of rising interest rates creating unrealised losses on the European banks’ fixed investment, fixed-income portfolios?

This is one of the risks that is well understood and is exactly why it’s important to pay attention that the size of the bond portfolio that a bank holds is not too big, that it’s properly accounted for, it’s properly managed, and that the banks have enough capital to guard against any loss in value of these bonds. This is why − because of the supervision actions and because, also from the banks’ own point of view, it would be too risky to take chances on this − we do think this risk factor is quite contained. What I would say is, from the European Central Bank’s point of view, we have taken a step-by-step approach to monetary tightening since around the end of 2021 to now. There has been a significant increase in interest rates, but it’s been gradual, it’s been step-by-step, and that has given the European system time to adjust to this change in the situation.

Following this turmoil, a lot of economists in the euro area have pointed out that we should reconsider implementing the European deposit insurance scheme, the EDIS, thereby completing the banking union. Do you agree with that?

I think we all share a common vision, that where we want to end up is at the full banking union, which includes EDIS, a European deposit insurance scheme. But I think everyone should recognise that to arrive at that destination it’s a step-by-step process. It’s important that there is momentum, that all of the prerequisites, all of the necessary steps, need to be delivered. As you know, this has been a conversation for the last number of years. What we’ve seen this year reinforces the value, not only of a full banking union, but also a full capital markets union in Europe. So we share that vision, absolutely, but it’s not a one-day decision, it’s not an overnight decision; a lot of different elements need to be delivered for that to be achieved.

Let’s turn to monetary policy now. The European Central Bank has raised its interest rates since July last year – six times, if I’m not mistaken – and my question is, are we getting closer to a pause in rate hikes? Is monetary policy restrictive enough, or are more hikes needed to combat inflation in an effective way?

I think we were clear in our March meeting and we made a further increase then. A lot has been done, but we’ve also been clear that our next decision in May will depend on three factors. It will depend on the inflation outlook − every week we have more information coming in, on the March inflation number that just came out, and we will have the April inflation number as well, before we meet in May. Number two, we have to diagnose the underlying dynamic, not just the overall inflation rate, but our assessment of how quickly inflation is going to fall. Conversely, the main concern would be if we assessed that inflation was going to remain too high for too long. Then the third factor is how quickly these interest rate increases are restricting the economy and bringing down inflation. So for these reasons we have no longer indicated or pre-announced what the expectation is for the next meeting or for the upcoming meetings. I think we will be looking very carefully at all of these data in the coming weeks.

So I think it’s important for everyone to understand that, rather than asking me what the next interest rate decision will be, the focus should be on understanding every data point that comes in. Are we seeing signs that inflation is cooling? Are we seeing signs that interest rate increases are reducing credit, for example? Are they leading to lower investment, lower consumption, lower pressure on the economy and, therefore, lower inflation? We still have quite a long way to go between now and the May meeting, which is about a month away. So rather than trying to predict now what the decision will be, our attention will be on the incoming data. We will analyse these until the day of the meeting and make a decision then.

Everybody continues to expect a rate hike from you in the next monetary policy meeting. But you said you aren’t pre-announcing it as you did previously, so is it a rate hike but a lower one? Or what direction are you taking?

The best way to capture this – I have said this, and my colleagues I think have all said it – is that in March we had a set of macro projections for the coming months. If, by the time of the May meeting, those projections remain on track, then a rate hike will be appropriate. However, we need to be scientific and data-dependent, so in these weeks we have to see whether the incoming data support that projection from March. If they create more inflation concerns, that will move us in one direction; if they create less inflation concerns, that will move us in another direction. So I think the formula would be: if the baseline we developed before the banking stress holds up, it will be appropriate to have a further increase in May. However, we need to be data-dependent about the assessment of whether that baseline still holds true at the time of our May meeting.

There has been a recent development – I’m referring to OPEC’s decision to reduce oil production, sending international oil prices soaring. Does this development complicate the ECB’s monetary policy stance?

The overall price of energy – the mix between oil, gas and electricity – is, of course, a big part of the inflation dynamic. Just in terms of energy, we’ll have to weigh the movement in oil prices, and this should be seen in the context of a fairly large drop in recent months. This is some reversal of that trend, but in the context of a fairly negative trend, we’ve seen a very large ongoing reduction in gas prices, and the reduction in pressure from energy reduces the pressure on the rest of the economy. And it’s not only about the mechanical effect of energy prices – one of the biggest issues for us is how the rest of the economy responds to the energy dynamic. Last year we had a lot of pressure on many sectors, because their utility bills went up so much. This year, with gas really improving quite a bit and with oil declining until quite recently, this will also relieve pressure on many sectors. So this is why it is really quite uncertain. This is why the data inflow is so important, because it’s possible to debate many possibilities, and we really have to see, in an overall context, the net impact of these dynamics.

One last thing. There is a lot of criticism here in Cyprus, and I think elsewhere, that the ECB is proceeding with its monetary policy – with rate hikes – while disregarding the consequences for the real economy and for borrowers’ ability to repay their loans. How do you respond to that?

We work very hard to try to make balanced decisions. We fully take into account the impact of these interest rate increases on those who have debt, who face a bigger repayment challenge, and the implications for investment and for households. But please remember, the reason why we are raising interest rates now is because inflation is high. In order to make sure that inflation comes back to a low number, to around our 2% target, we do think it’s necessary, it’s unavoidable, to make these interest rate increases. If we did not do this, if we kept rates too low, we think inflation would remain too high for too long, and this would not serve anyone. It would mean, in fact, a tougher economic situation for a longer period of time. So a period now of raising interest rates is the best route to stability, is the best route to making sure the economy is in good shape, and that the cost of living stabilises. Of course it’s difficult for those who were hoping for low interest rates, but this is an important episode. It’s important for us at the ECB to make sure that the interest rate policy responds to the inflation challenge. And for those who are expressing these concerns, I’m sure they share my conviction that all of us need to see inflation come back down to a low number, around 2%, as soon as possible.

Besides, high inflation would hit them from a different perspective.

Right. Here and elsewhere, those that suffer most from high inflation are those on low incomes, who right now are facing very high food prices and still absorbing the increase in electricity and gas prices last year. It’s in everyone’s interest not to allow inflation to remain too high for too long.