Interview with El País

Interview with Frank Elderson, member of the ECB’s Executive Board and Vice-Chairman of the ECB’s Supervisory Board, conducted by Luis Pellicer

March 30, 2023

You said eurozone banks are safe. Have all the financial crisis contagion channels been closed?

The Eurozone banking system is healthy and resilient, with strong levels of capital and liquidity. It also implements a post-crisis regulatory regime under strict oversight. Moreover, the ECB is ready and has the tools it needs to provide liquidity to the system when needed. I made that clear. We’re not caught between a rock and a hard place, as our decision to raise interest rates by 50 basis his points shows.

Two weeks into the crisis, things are still chaotic. Do you think you should use those tools?

As I said, banks are resilient, well capitalized and well supervised.

Some have compared the Silicon Valley Bank (SVB) crisis to the 2008 Bear Stearns crisis.

No, this situation is very different. After the Great Financial Crisis, Europe faced a powerful challenge of regulatory reform. These changes have been implemented and banks are subject to Basel III and European banking supervision. Besides, SVB had a very specific business model. It was highly exposed to interest rate risk and had a highly concentrated deposit base. Deposit-dependent business models are more diversified among ECB-supervised banks.

However, some analysts believe that rapid rate hikes by central banks after the ultra-low interest rate era are also behind the banking crisis…

What is clear is that inflation is too high and must be brought down. That is what prompted the tightening of our monetary policy. Financial stability is necessary for the smooth transmission of monetary policy and a prerequisite for achieving price stability. But as I said, we have the means to address both sides.

In the specific case of SVB, the bank was highly exposed to interest rate adjustments and its core operations were highly concentrated. These features are less pronounced for Eurozone banks.

Will there be a Swiss decision to impose losses on riskier bond holders before shareholders impact the eurozone banking system?

Eurozone banks have very limited exposure to the high-risk Credit Suisse bonds that have been wiped out. Moreover, in the European Union, shareholders are always the first to absorb losses. These high-risk products will only be affected after that. This approach has been consistently adhered to and, as we recently reiterated in our joint statement with the Single Resolution Board and the European Banking Authority, guides our actions in crisis cases.

At the last board meeting, you decided to go ahead with the plan and raise the interest rate to 3%. Would you have made the same decision today?

At the last board meeting, we agreed to the rate hike already announced in February. That decision is as solid today as it was when we made it, given the general outlook that inflation remains too high. That said, it is true that we did not give specific intentions on future decisions as we have done in the past, given the uncertain impact of recent market tensions on our inflation outlook. , in our view it was best to be clear about the reaction function. In other words, it describes the factors to consider in the future when making decisions. It has three elements. Inflation outlook based on analysis of future economic and financial data. The underlying inflation dynamics. The strength of the spillover effect of monetary policy. In other words, we do not preempt future decisions, but remain committed to ensuring that inflation returns to his 2% target over the medium term.

So you didn’t agree to raise interest rates by 0.5% to avoid sending a pessimistic message to the market?

We already made it clear in February that this was our intention. At the time, there was already a high degree of uncertainty due to many factors, including the aftermath of the pandemic, Russia’s illegal war in Ukraine, and the ongoing climate and environmental crisis. And now financial market tensions are on top of that. But it is clear that inflation is still too high, and keeping it in check is our main objective. This allowed us to realize our intention to raise interest rates by 50 basis points. The increased uncertainty also led to very clear guidance on the reaction function.

Before the Governing Council meeting, the Spanish government called on you to be cautious in light of market tensions. was it you?

We need to achieve the price stability target. European citizens trust us to make it happen and we owe them. At our last meeting, we sent a very strong signal of our commitment to this.

I am fully aware of how difficult it is for many people to reach the end of the month even in Spain due to the current economic and financial situation. In general, monthly payments for variable rate mortgages increased by an average of €400. I understand how frustrating it is. But we must distinguish between the disease, which is inflation, and the drug, which is rising interest rates. Many medicines taste bitter, but they make the disease worse if you don’t take them. In this case, when high inflation takes hold, it is the people who are already suffering the most who will pay the price.

That metaphor takes me back ten years. I was told that austerity was a drug I had to swallow to recover, but it turned out to be harmful…

I get what you’re saying, but the best thing we can do is get inflation back to our 2% target as soon as possible. That is our mission and what we are working on. So you have to go through this hiking stage. Moreover, this situation is completely different from what happened more than a decade ago. The ECB has acted swiftly, taking an accommodative policy stance essential to weather the impact of the pandemic. We are now in a different situation where high inflation is the biggest problem and we need to act again.

ECB staff now see average inflation of 2.1% in 2025, just 10 basis points above the ECB’s target. Does this mean interest rate increases will start to slow down?

The latest forecast, which was finalized in early March, sees headline inflation at 2.1% by the end of 2025 and core inflation at a slightly higher 2.2%. These forecasts are based on his technical assumption of a cutoff date of February 15, and therefore do not take into account recent market trends. This is exactly why I wanted to clarify the reaction function. This is to show that the decision must be made based on the input data. Data evolves, and so do our assessments. As such, the decision to be made in May cannot be put off today.

We raised the interest rate six times in nine months, from -0.5% to 3%. Afraid of economic damage?

If it takes hold, the high inflation we are experiencing in the Eurozone will hit the economy hard, primarily affecting the most disadvantaged. The ECB must counter it. That is our mission. And the primary tool for fighting inflation is interest rates. Restrictive monetary policy reduces inflation by removing excess aggregate demand. While this will lead to a slowdown in the economy in the short term, in the medium to long term society as a whole will benefit when inflation eases. Price stability is a prerequisite for sustainable growth.

How long will monetary policy cool the economy and stay in restrictive territory?

Along the lines of the reaction function already mentioned, we can see how much and for how long it needs to be capped in order to reach the inflation target. If the baseline scenario we discussed at our last meeting continues, this is a big ‘if’, but there is still room to cover and interest rates will need to rise further. These grounds to cover depend not only on how market tensions play out, but also on the convincing cornering of underlying inflation. But there are certainly additional uncertainties, so we can’t say exactly how monetary policy will evolve from here.

In Spain, mortgage payments have increased rapidly, but the same has not happened for deposit rewards. what do you say to the bank?

It is between banks and their customers. Economically, it makes sense that as interest rates rise, the rewards on deposits should also rise. This is part of the transmission of monetary policy. Delays can occur, especially if there is still a lot of liquidity in the system, but that is the logical consequence of raising interest rates.

Unidas Podemos, a minor party in the Spanish coalition, has proposed capping mortgage payments. do you think that is possible?

I am not the one to comment on proposals from political parties. In general, I understand why governments are taking various measures, but these measures are temporary, aimed at those who really need them most, and are not tailored to specific circumstances. It is important to be We analyzed all government support measures across the Eurozone, and only 10% targeted low-income households. There are two important points here. First, we need to make sure government finances are sustainable. Second, the measures must be temporary and targeted, as they could create more inflationary pressure if these conditions are not met. And that means more must be done to achieve the price stability target.

Is it time to withdraw these measures?

As energy prices fall, it is important that European governments withdraw measures where possible.

This month we also started to reduce our balance sheet. Until June, it is shrinking at a pace of €15 billion per month. Given the economic strain, could you slow down?

Currently, interest rates are the primary means of adjusting to pursue the price stability mandate, based on the reaction function. To complement that, we will continue to reduce our fixed income portfolio in a balanced manner.

So far, spreads have been contained. Do you expect the current turmoil to start affecting the debt of peripheral countries such as Spain and Italy?

There is no cause for concern in the bond market. If tension arises in the future, we have all the means at our disposal. This includes the Transmission Protection Instrument (TPI), which allows countering the risk of fragmentation that could threaten the transmission of monetary policy to all eurozone countries.

Has the use of TPI ever been discussed in a conference?

it wasn’t needed. But the necessary elements are in place to ensure smooth transmission of monetary policy.

The energy crisis has highlighted the need to accelerate the energy transition. How can central banks contribute to this end?

Having just disclosed the carbon footprint of the ECB’s balance sheet and the Eurosystem’s corporate sector holdings, it is gradually decarbonizing on a path aligned with the goals of the Paris Agreement. We also take measures related to our collateral framework and risk assessment and management tools. Furthermore, our aim as banking supervisors is to enable banks to effectively manage all climate-related and environmental risks and to be resilient in an economy that needs to pick up the pace towards net zero emissions. It is to To achieve this, we have developed a multi-year plan to ensure the bank meets our expectations. We also pledged to do more within our mandate, if necessary, to continue to support the goals of the Paris Agreement.