Interview with Le Monde
Interview with Philip R. Lane, Member of the Executive Board of the ECB, conducted by Eric Albert on 18 April 2023
25 April 2023
Last autumn, a euro area recession at the beginning of 2023 seemed inevitable. Has it been avoided?
Yes, the indicators show that the European economy has been growing in the first few months of the year. The main factors behind this have been the fall in energy prices, especially gas prices, and the easing of bottlenecks. This has caused a visible improvement in the confidence of consumers and firms.
In March, the ECB was forecasting euro area growth of 1% for 2023. Are we still on track?
That forecast remains reasonable. But I must emphasise that there are still factors that are causing significant uncertainty: there are many questions about the state of the world economy, about Russia’s war against Ukraine, and about the impact of monetary tightening. It’s important to remember the scale of the challenges facing Europe and the world economy. After a fairly long period of falling gas prices, the weather could turn, the war could deteriorate even further, or there could be more changes in OPEC policy. All this could increase energy prices. And central banks around the world have been hiking interest rates, which has been necessary, but there is a lot of uncertainty about the impact of this policy – about whether it will deliver a soft landing for the world economy or result in a downside risk to economic performance.
So, essentially, it’s a bit better than expected, but the economy is still more or less stagnant?
Not stagnant but, compared with what we expected before the pandemic and before the Russian war against Ukraine, the European economy is currently on a much more modest path.
One of the positives is that euro area unemployment has remained quite low, at 6.6%. Does this partly explain the resilience of the European economy?
It’s good news. For many people, the worst-case scenario is losing their job. So a strong labour market is an important confidence factor for consumption. I would point out that the strength of the labour market has been associated with a strong return of immigration into the euro area. We were concerned that there might be less immigration after the pandemic, but it looks like it has come back. It is a source of labour for all of those industries that have been experiencing worker shortages. The participation rate of older workers is also much better. And working from home has enabled many people to join the labour force. All this allows the labour supply to grow and it’s why we can have a strong labour market without wage pressures necessarily overheating.
So you don’t see the beginning of a wage-price spiral? That was a major worry for central banks.
Last year, wages were relatively slow to move. Many firms were able to increase their profits. This year wages are growing at around 5%, well above their normal rate, but we expect a slowdown later this year.
For most households that is still a decrease in real terms…
As a result of the energy shock, the euro area now pays a lot more for its energy imports. This is a collective loss that cannot be escaped. We have to accept that there cannot be total protection from price increases due to higher energy prices. Unfortunately, living standards do have to adjust to it.
Inflation has been falling quite a lot, from a peak of 10.6% for the euro area last October to 6.9% in March. Is it under control?
This significant drop is welcome, as it reduces pressure on the cost of living. Inflation should continue to fall because of the easing of supply chain bottlenecks following the normalisation of the economy after the pandemic, and because of the reversal of the energy situation. Nevertheless, for central banks, it’s not the drop from 10.6% to 6.9% that’s most important. What’s most important is making sure that we get close to our target of 2% within a reasonable time period.
Why “within a reasonable time period”?
Inflation has been above our target since the middle of 2021, so inflation has been too high for almost two years. And the longer inflation stays too high, the greater the risk that people’s perceptions will change, that they will lose faith in our ability to return to our 2% target. That is not the case at the moment, but it’s why we want to return inflation to 2% in a timely manner.
You have already increased interest rates by 3.5 percentage points (the ECB’s deposit rate has increased from ‑0.5% to 3%), which is unprecedented in the history of the euro area. How effective has this measure been so far?
The markets and banks are starting to charge much higher interest rates. As a result, for households we are seeing a strong fall in demand for mortgages. For firms, we are seeing a substantial drop in investment. The interest rate increases have also supported a strong appreciation of the euro. All of these impacts will continue to filter through the economy – this is going to continue to play out.
In this context, at what point should you stop raising rates?
For our next Governing Council meeting on 4 May, the current data are indicating that we should raise rates again. This is still not the right time to stop. Beyond that, I don’t have a crystal ball; it will depend on the economic data. But the analysis suggests that it would be inappropriate to leave our deposit rate at the current level of 3%.
Inflation has been very high since autumn 2021. Are you not worried that it has become “sticky”?
“Sticky” would mean that inflation will remain where it is. But that is not what is happening. There are many phenomena underlying the current inflation figures. First of all, we had the pandemic, which created many bottlenecks. Then there was the energy shock due to the Russian war against Ukraine. Today, it’s food prices that are very high. But on the flip side, energy prices are falling more quickly than expected. Inflationary pressures remain in certain sectors of the economy, but are easing in others. I don’t think we are in a 1970s-style situation, when inflation was in fact sticky. But there is a risk that we could end up there. That is why it’s important that the ECB raises its interest rates to ensure inflation returns to 2% in a timely manner.
In March, the beginnings of a banking crisis shook the markets. How do you see the situation?
The banking issues in the United States [collapse of SVB] and Switzerland [turmoil at Crédit Suisse until it was taken over by UBS] sparked a series of questions about the European banking system. There was some contagion, but investors very quickly understood that the euro area banking system is very different because it’s closely supervised, and that the problems we saw in the United States and Switzerland are less likely to materialise in the euro area. It of course remains the case that the large increase in interest rates entails a significant adjustment for the financial system.
Christine Lagarde, the President of the ECB, has repeatedly called on governments to reduce their support for firms and households with regard to gas and electricity bills. Why?
There are two messages here. First, governments decided on their subsidy programmes when gas prices were very high. Now they are falling, it’s logical for us to recommend that governments reduce these subsidies. And second, if fiscal policy injects less stimulus into the economy, inflationary pressures will be lower over the coming years. As a result, inflation will return to our 2% target more quickly, meaning interest rates would not need to rise more than necessary.
Does that mean that the era of free money is over?
Let’s differentiate between two phases. First of all, it’s true that nominal interest rates will be elevated for the next few years. But after that, even when inflation has returned to our target of around 2%, financial markets are not expecting interest rates to return to the very low levels we had before the pandemic. On the contrary – markets expect rates to normalise at around 2%. This means that the era we were living in for a long time before the pandemic and during the pandemic itself – one of extremely low interest rates – should not return.
But let’s not forget that, in the long term, an interest rate of around 2% is not particularly high. All of the factors that existed before the pandemic – an ageing population, low growth, etc. – are still relevant. So I would not exaggerate the turnaround in the situation.