Interview with Corriere della Sera
Interview with Philip R. Lane, Member of the Executive Board of the ECB, conducted by Federico Fubini
13 January 2024
The rate hike in September was meant to increase confidence that the ECB would achieve its inflation target, so it was like taking out extra insurance, in a way. In light of recent, more encouraging data, is that extra insurance still warranted or can it be rolled back?
The first point to make is that there has been progress on inflation in recent months. It is hard to be exact about the role of individual hikes, but of course the September interest rate hike has helped with that. By underlining that the ECB will maintain a restrictive policy, it has helped cool down inflation expectations and moderate price setting in the autumn.
Second, once the ECB begins lowering interest rates, this would not be by a single decision of a rate cut, there would most likely be a sequence of rate cuts. The September hike means the peak rate has been higher than it otherwise would have been. I recognise that there was an insurance element in that rate hike. And I will fully take that into account in terms of the scale and timing of the rate adjustment towards a more neutral monetary policy stance when it comes to it.
What is it that the market is getting so wrong by expecting ECB rate cuts by March or April, and for these to then continue rather aggressively in 2024? Do you believe the market discounts euro area recession, due in part to a more restrictive German budget, that were not included in the more recent ECB staff projections?
The inflation release for December was broadly in line with our projections – I’m not seeing some major downside surprise. It was in line with our signal that there would be a jump. And the continued progress on the easing of core inflation is welcome. But we do see some headwinds to services inflation this year and, for the time being, wages are still growing well above any kind of long-run equilibrium rate. We don’t expect energy prices to continue falling at the same rate as last year.
Our baseline staff projections include a significant recovery in the European economy this year due to stronger demand in Europe which is, on its own terms, inflationary. But we flagged in December that there are downside risks to our forecast. And that is one of the big data questions we have for these weeks: will we see a recovery or a continuation of the kind of stagnation we had for much of 2023? We remain very data dependent.
Peak monetary policy restriction will coincide with the onset of tighter fiscal policy, especially in some of the larger euro area economies. How much are you incorporating these effects into your expectations?
Our December projections do have an assumption of fiscal tightening in 2024, in line with what was contained in the draft budgetary plans of euro area countries. The fiscal tightening is essentially due to the ending of the cost-of-living support measures, energy measures, and so on. Then, late last year, we also had the German court ruling, which has led to some revision in Germany. But I think for 2024 the scale of the revision is not large enough to lead to a significant change in the inflation outlook.
The ECB needs to assess wage settlements before getting an orientation on monetary policy in 2024. Many wage deals will happen this month and during the spring. Do you think you will have a clear enough idea by the governing council on April 11th?
I have a range of data I want to see. We do receive the data on the latest wage settlements every week. We have a wage tracker measure that we use as an early indication of the wage dynamics. We also look at market data on wages. But the most complete dataset is in the Eurostat national accounts data. The data for the first quarter will not be available until the end of April. By our June meeting, we will have those important data. But let me emphasise, we do have other data that we will be looking at every week, because, as you say, a lot happens every month and we look at all of the data available to us.
It will take time to have a good understanding of whether the wage settlements are decelerating. We expect that 2024 will still have high wage increases, and it is important for people to recover the losses from high inflation. But the scale of that will determine the timing and the scale of rate adjustment this year.
Most euro-area countries have experienced serious drops in real wages, especially Germany and Italy. What is a fair and compatible wage settlement to you: 2% to compensate for inflation, plus 2% to account for expected productivity growth? Maybe there should be some little extra-compensation, given purchasing power losses since 2020?
For the whole euro area, if inflation typically should be 2 per cent and labour productivity grows at 1 per cent, then the rate of a wage increase consistent with a 2 per cent inflation target is around 3 per cent. In 2023 we had increases of about 5 per cent and in our projections we now have wage increases coming down by maybe a percentage point in 2024, then above 3 per cent in 2025 and at around 3 per cent in 2026. So for this year and next year we still expect high levels, to compensate for the high inflation, especially in 2022. This is natural. But the adjustment of wages is a multi-year process. If countries try to do it very quickly with very large wage increases, then you could get a wage-price spiral. It’s going to be a gradual process, in the interest of everyone.
Representatives of the Italian government have been vocal a number of times that they criticised the ECB after hiking decisions. What’s your message to them?
The inflation situation is very unusual, the surge in inflation was very intense. But of course we also saw significant disinflation last year. We had very atypical factors driving inflation as, historically, monetary policy tightening was often meant to cool down an overheating economy. We did not have an overheating economy in the euro area. The inflation was primarily coming from supply shocks caused by the pandemic and Russia’s aggression in Ukraine. But it’s very important to appreciate the role of interest rate rises, even when the origin of inflation is a supply shock. There is a risk that inflation becomes embedded. If people expect inflation to remain at a high level, then firms would try to set high prices, and workers would then have to respond by claiming higher wages. You can get into a situation where high inflation becomes embedded. If we had not hiked interest rates, we could have seen more of that original temporary supply shock converting into stagflation.
Government politicians in Italy say the government budget will depend on monetary policy. What the ECB will do will impact the cost of debt, and essentially inflation has come down. Why doesn’t the ECB cut rates at this point?
For governments, the long-term interest rate is the most important one, as they issue a lot of ten-year bonds and so on. The market is taking the view, which I share, that we have done a cyclical increase in interest rates; it’s temporary. So long as inflation is confirmed as returning to 2 per cent, it will be appropriate to normalise interest rates. And that will help to lower the costs of government debt. But to get there requires us to hold steady and make sure that the inflation problem is fully defeated. The history of high inflation episodes tells us that if central banks try to normalise too quickly, before the problem is really conquered, then we get another inflation wave, and then another wave of interest rate hikes. That would be a far worse scenario. So it’s important for us to take our time and make sure there’s enough evidence that inflation is securely returning to target. A false dawn, too rapid a recalibration, can be self-defeating. We don’t want to overtighten and keep rates too high for too long. But, equally, it is important not to prematurely move away from the hold-steady position that we have been in since September. What moves us from holding steady into active normalisation will be an important discussion. But it’s too early, we have not yet seen sufficient evidence to move to the next stage.
Italy has not ratified the ESM Treaty reform. How does that fit the completion of the Banking Union?
We think it’s very important that the Treaty is ratified and exactly for the reason you mentioned. Europe faces many challenges. There needs to be a lot of investment in Europe to fund the green transition, improve productivity, improve dynamism. We now have Next Generation EU, which will help for the next couple of years, especially in Italy. But when we look ahead, we need the banking system to fund a lot of investment. In turn, for that to happen, we do need to make progress on banking union. And for the ESM to be a backstop to the Single Resolution Fund, we need the Treaty to be ratified.
There is some pressure from the US for Europe to step up efforts to seize Russian official reserves to pay for Ukrainian support and reconstruction. Do you see it as a viable course of action? There are risks, aren't there?
Of course, this decision is for political leaders of the major advanced economies. From a central banking perspective, it’s important that this decision fully takes into account the implications for the international monetary system, for financial stability and the legal foundations of the international system. From our point of view, it’s important that all of these risk factors are fully assessed as part of that decision-making process.
Do you worry that if governments seize euro-denominated reserves, the status of the euro as an international reserve currency might be questioned in some other quarters, maybe in the emerging world, as other countries that might have concerns that one day their reserves in euros might be seized as well?
That requires a full analysis. So I’m sure all the different policy teams looking at this will be examining these questions closely, but it’s important to take these risks seriously as part of that decision process.
EU governments have agreed on a new fiscal framework and maybe it’s slightly more complex than the Commission was hoping for. What do you make of the final result?
A fiscal framework has to be based on a consensual agreement among EU governments, and the compromise reflects that. The kernel of the framework still has many of the elements that the Commission proposed. The new framework includes numerical guardrails, but the guardrails only kick in under various sub-scenarios. Under the baseline scenario the Commission proposal will be the baseline guidance for fiscal policy, which takes into account, very importantly, the multi-year approaches to fiscal adjustment and the role of reforms which can play out over multi-year horizons. So I think it’s a fiscal framework that can be operational.
Aren’t the safeguards going to make the rules too restrictive?
We do need a framework to help governments bring down debt ratios over time. It’s important to acknowledge that this is an objective. But everyone, I think, has learned that this has to be done carefully in a way that is sustainable.
Could the Red Sea crisis, and possible new attacks on oil tankers around the Strait of Hormuz following the Western bombing of Houthi positions, trigger economic repercussions in Europe and globally?
It’s very important that the world has secure shipping routes and steps are taken to make that route safe and secure again. If this turned out to be a longer-term problem and world trade had to be redirected, that would be a new type of unwelcome bottleneck. But, even in that scenario, different effects are possible. Mechanically, higher shipping rates would add to the costs of industry. But you also potentially have a disinflationary effect, which would be unwelcome, in which many businesses around the world may just simply cancel orders and postpone investments. The result would be a more pronounced slowdown in the economy. But, also more generally, geopolitical risks may result in firms and households becoming less confident in the future.