February 10, 2023

Interview with Luis de Guindos, Vice-President of the ECB, conducted by Markus Zydra and Meike Schreiber

Mr de Guindos, energy prices have fallen recently. Is the inflation nightmare coming to an end?

No, we should still be concerned about inflation. There are indeed some favourable developments which are alleviating the pressure of inflation, including the easing of energy prices you mention. The euro’s appreciation in the foreign exchange markets is also contributing. Moreover, there are fewer pandemic-related supply shortages. However, we see that the reopening of the economy in China after the lockdown is leading to greater demand, for energy, for metals and for commodities. That can generate more price pressures. And wages are rising too.

Aren’t employees justified in asking for higher wages to offset inflation?

Yes, of course they are. But a wage-price spiral must be avoided. Parties in the ongoing wage negotiations are looking back to the high inflation of the past year. But inflation will abate in the course of the year: we expect an average inflation rate of around 6% this year, with 3.6% in the last quarter. The trade unions may, however, be inclined to ask for excessive pay rises. We need to be careful.

Isn’t that a bit harsh? Low-income households have been particularly hard hit by inflation.

If we enter into a wage-price spiral, the ECB will have to raise interest rates by more than would otherwise have been needed. In a wage-price spiral no one wins. Governments need to offer support to those who are worst affected, by introducing targeted subsidies to mitigate the impact of inflation. People could then reduce their wage demands and the ECB would not have to tighten its monetary policy so much. That would benefit everyone.

Many people are angry: inflation is easing, but only slowly. And prices remain high, they will not fall back to 2021 levels.

That’s true. Even if inflation is gradually slowing down, prices are now generally at higher levels than they were one or one and a half years ago. I understand that people find that disappointing. But this inflation was caused by extraordinary shocks: the sudden reopening of the economy after the pandemic and the war against Ukraine. The ECB now has to ensure that inflation returns to our 2% target.

Looking back to a year and a half ago: in view of the high inflation, what would the ECB accept it got wrong in its monetary policy?

Central banks and many other organisations believed for a long time that the increase in inflation was temporary. I have to admit: that was a mistake, but the level of uncertainty was enormous. We all underestimated the persistence of inflation. In December 2021 we already decided to stop our pandemic-related net asset purchases and in July of the following year we started to raise interest rates. With the benefit of hindsight, we should have started reacting even sooner.

Should the ECB apologise to the public for this mistake?

We can’t change the past, we need to look towards the future. The best thing we can do is to bring inflation back down to our target of 2% as soon as possible.

To what extent have people lost trust in the ECB because of the high prices?

Surveys show that most people trust us to be able to bring inflation back down to 2%. That emerges clearly from measurable inflation expectations: households and firms expect inflation to fall back again soon.

Equity markets are rallying again, as investors are betting on inflation easing and on an imminent end to interest rate hikes.

Financial markets may well be overly optimistic with regard to inflation developments and our monetary policy response.

When will the interest rate hikes come to an end?

We increased our policy rates by 0.5 percentage points last week, and will very likely raise them by another 0.5 percentage points at our next meeting in March. We will then see what we will do. I would not rule out further rate hikes after March. The battle against inflation is not over yet. In the euro area consumer prices still increased by 8.5% in January (considering an estimate for Germany), despite the fall-off in energy prices. At 5.2%, core inflation, which excludes energy and food prices, is at its highest level in the history of the monetary union. That is not good.

Excessively high interest rates could damage the economy. Is the ECB in danger of going too far?

Our mandate is to maintain price stability. That’s it. That’s the only mandate we have. High inflation harms everyone in society.

Interest rate hikes act with a time lag. Have the measures had any visible effect at all so far?

Our interest rate policy takes one to two years to have an impact. But we are already seeing its initial effects: borrowing costs for households and businesses are rising, for example, and this is weakening demand for loans. In turn, that is helping to cool the economy and is leading to lower price increases.

A question on financial stability. The highly indebted conglomerate, Adani, is now under attack from a short seller. If Adani collapsed, it could take down the Indian banking system with it. Western banks are hugely exposed to it too. Are you worried about that?

We don’t comment on individual companies. Leaving that aside, European banks have proven to be very robust on average. Their profit margins shot up recently, making them more resilient, partly due to higher interest rates. On the other hand, the current economic slowdown could also have consequences. We are of course keeping a close eye on the non-bank financial sector, or shadow banks. Two years ago, for example, the difficulties at the private investment firm Archegos caused several banks to suffer major losses. We need to closely monitor risks like this. More generally, we basically see two main risks for financial stability in the euro area. For one thing an overoptimism in the financial markets about the inflation outlook and the monetary policy response, and for another a possible contradiction in the direction of fiscal and monetary policies.

Source: European Central Bank
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