Interview with El Confidencial

Interview with Philip R. Lane, Member of the Executive Board of the ECB, conducted on 30 April 2024 by Miquel Roig, Javier Jorrín and Óscar Giménez and published on 6 May 2024

6 May 2024

Question: The euro area is struggling to keep pace with growth in the United States and China. Are you in any way concerned about Europe falling behind those two economies? Or do you think it’s something temporary and we’ll catch up eventually?

Europe needs to focus on its own performance. Of course, it’s interesting to use global benchmarks, but in the end the performance of the European economy is going to depend on the choices made by European businesses and governments. At the same time, in recognition of geopolitical tensions, Europe has a strong incentive to make sure that it has good economic security into the future.

In Europe we have seen that higher interest rates have affected investment. Are you concerned that this could be affecting current or potential GDP growth?

It has to be recognised that high interest rates hold back investment. And, as you say, a lack of investment over time would hold back the potential of the European economy. But we are setting interest rates to ensure that inflation returns to target. Once that is achieved, when we are confident that inflation will return to target, then we have said that it would be appropriate to reduce the level of interest rates. There is a cost to high interest rates and we should only pay that cost so long as we have excessive inflation risk. As inflation risk comes down, the current level of interest rates should not be sustained indefinitely. And that will make room for investment.

At its last meeting the ECB warned that domestic inflationary pressures were intense and services price inflation was still elevated. Does this assessment remain unchanged?

The overall narrative that we have seen in the last number of months is that there is a lot of progress in relation to goods inflation and food inflation. And earlier on we saw an improvement in energy inflation, although it’s now reversing somewhat, at least in relation to oil prices. So the remaining question is services inflation. And the latest numbers for April do show some progress. We were at 4 per cent services inflation for five months in a row. And the April services inflation number released last week was 3.7 per cent. We did expect some progress in services inflation, so I think this is an important initial step in the next phase of bringing inflation down. It has historically been the case that services inflation is the component that is closest to the domestic economy, as it is closer to wage inflation. And I think this applies worldwide. The focus now is on making sure that services inflation does not derail the return of overall inflation to our two per cent target.

Do you think there is room for a surprise at the next ECB meeting in June? Or do you think that the lower interest rates are coming during the June meeting?

What we said in April was essentially that if our level of confidence in the overall return of inflation to our target were to improve, then it would be appropriate to come down from the current level of interest rates. We have a number of weeks before the June meeting, but the April number is important. Both the April flash estimate for euro area inflation and the Q1 GDP number that came out improve my confidence that inflation should return to target in a timely manner. So, as of today, my personal confidence level has improved compared with our April meeting. But of course, more data will arrive between now and June.

So the surprise would be no rate cut.

At this point, of course, the market believes a rate cut is coming, so a cut would not be a surprise. Last week’s numbers were a big part of the information we were waiting to see. But we will have another month of inflation data when we meet in June. And we will also have more information on wage dynamics. It’s not necessary to make excessively certain statements. Let’s use those weeks to look at the incoming data.

After the summer, could we see a cycle of rate cuts at the ECB if the Federal Reserve keeps interest rates unchanged?

We are going to be driven by the European outlook: the outlook for inflation, first and foremost, but also the outlook for the economy. This includes what we have already discussed, which is the importance of investment for long-term growth. If the question is whether events in the United States, including decisions taken by the Federal Reserve, affect the outlook for European inflation and the European economy, my perspective here is probably that we should not exaggerate the impact. The US economy and US interest rates affect the euro area in different ways, and essentially, these different mechanisms work in opposite directions. Some people might look at the possibility of a depreciation of the euro against the dollar. But, on the other hand, if the US bond market is offering high interest rates, that will put upward pressure on bond yields in Europe, which would basically have the opposite effect to the depreciation. So when you add those effects together, the net impact on the European economy is largely contained. It’s an example where we have to measure the exchange rate impact versus any bond market impact. And we will be doing this at every meeting before the summer, during the summer and after the summer.

Do you think the Governing Council could be divided on the June decision?

We all, and this is true for me as well, try to think about a number of scenarios: a baseline scenario, an upside scenario, in which inflation is going to be stronger, and a downside scenario. And this brings us back, essentially, to the importance of being data dependent at each meeting, given that the relative likelihood of each scenario materialising will evolve over time. In the end, the Governing Council is able to make decisions by consensus. So I don’t find it productive to focus on the differences in articulation of the upside and downside risks.

Have you observed a change in the natural rate of interest? Has there been an increase in the marginal propensity to consume?

This debate will be more relevant next year. Right now, we are not close to the natural rate of interest. We don’t need to think very hard about this topic. Clearly, at some point, as inflation returns to target and if we don’t face any shocks, we will have to think about it. In the European context, in terms of the ingredients of the discussion about any increase in the natural rate, there would need to be a structurally higher level of investment, but we don’t see this at the moment. We would also need to see savings rates falling, but in Europe the savings rate is still relatively high. So in order to think about upward pressure on the natural interest rate, it’s a combination of upward pressure on investments and downward pressure on savings, neither of which we have very strong indications for right now.

Do you think there are excess savings in Europe?

There are many ways to think about this. From an accounting perspective, Europe has a current account surplus, which is one way to think about the fact that Europe’s total savings exceed its total investment. Another way of thinking about it is that we have too much money in bank deposits and other forms of savings. And there is not enough money flowing into more productive, but potentially riskier, forms of investment. And this is connected, of course, to the debate about the importance of a capital markets union in Europe, which could give more European savers the confidence to put their money into investment vehicles that can offer better returns over the longer term. This could be very beneficial for savers, but also for companies, who would be able to obtain other types of financing.

In some countries, like Spain, the banks have been paying less on deposits than during other hiking cycles. Does this affect monetary policy transmission?

We see a lot of differences across European countries. For countries where deposit rates have not increased very much, this indicates insufficient competition for savings. And it is also indicating that the issue is insufficient investment because, of course, if the banks had a lot of demand from their business customers or from households for mortgages, they would be more interested in attracting deposits. So the fact that they are choosing not to pay very much on deposits also reflects the lack of dynamism in investment and the high savings rates. This brings us back to the topic of weak investment demand and high savings, and much of this is linked to the situation in Europe, including Russia’s war against Ukraine. The increase in energy prices two years ago is still having ramifications, even if prices have been falling.

You mentioned the competitive environment for banks. In Spain two large institutions – BBVA and Sabadell – are considering a potential merger. Does this affect monetary policy?

I’m not going to comment on a specific merger – that’s the responsibility of competition authorities and supervisors. We have a very good separation between banking supervision and monetary policy.

Do you think the process of rate cuts could increase the credit supply in Europe?

Probably, yes. This is why it’s so important that the European economy grows, too. We’ve had growth of 0.3 per cent in the first quarter. If we find ourselves in a situation where inflation is falling and there is concrete evidence that the European economy is recovering, then the banks can be more confident when supplying credit and households can be more confident when looking to borrow. I think that, after a long time in which there has been very little in the way of credit dynamics, these factors will support the recovery of credit supply and demand in the European economy.

If a cycle of rate cuts begins, are there risks to financial stability?

Credit has been very subdued for quite a long time. In a context where interest rates might fall, the level of credit restriction would also fall. We’re not talking about reaching the extremely low interest rates that were in place before the pandemic. Under such circumstances, we will always pay attention. But what I would say is that it looks more like the kind of environment in which credit could normalise, and not that we will see some kind of high-risk credit boom taking hold. We don’t see any indication of that.

In recent years we have seen very low sovereign bond spreads in the euro area. Do you think risk premia could increase in the coming months or years?

Let’s think about the factors that matter for spreads. First, we have the performance of the economy. If there are better growth numbers and better data coming out of the highly indebted countries of Europe then that will help limit the spreads. And second, if inflation falls and we can normalise interest rates over time, the overall environment will be less risky. Therefore, spreads will likely also be contained. And a third element is going to be very important: it’s not a question of the next few months, but the coming years are crucial for Member States to ensure that the high debt ratios come down. This will be something that is very important to maintain over the coming years, in line with the new European fiscal framework.

Do you think that the political uncertainty in Europe, with the upcoming elections, and in Spain makes reducing debt levels more difficult? How can the ECB manage this situation?

In our monetary policy statements we have basically said that we need to see how the new European fiscal framework is implemented. It is not for us to get into the details of how Member States carry out their fiscal plans. When thinking about fiscal policy, it’s important to take a multi-year horizon and look beyond any one electoral year. Of course, the European elections are important, but reducing debt is a multi-year challenge.

What’s your view on the Spanish economy?

From what I can see, it’s welcome to see a strong performance. What’s interesting, not only in Spain but also more generally, is that there has been a sustained improvement in tourism. It’s not just a domestic development. There has been a clear recovery in international tourism, including from North America into Europe. For Spain and other countries that were beneficiaries of Next Generation EU funds, these are important years ahead. Spain’s economic growth is welcome, but all the recipients of the Next Generation EU funds, which are limited in time and will not last forever, should be focused on implementing the investment plans, as well as the reforms.

How do geopolitical tensions, such as those in the Middle East or the war in Ukraine, affect monetary policy decisions?

I think they have different implications. If you look back to 2022, when Russia launched its unjustified invasion of Ukraine, there were numerous consequences, the most obvious being the surge in gas and energy prices. But overall, consumer and investor confidence in Europe have been subdued compared with the United States. More generally, geopolitical risks are clearly significant for the future of the global economy, and Europe’s economy is very integrated with the global economy. Regarding the events in the Middle East, we need to be very careful in our analysis: is the situation stable, is it improving, or is it worsening? It is a month-by-month assessment, but in the longer term we have to accept that we live in a world that is going to face a lot of geopolitical tensions over a number of years.

Since the pandemic, southern Europe has outperformed northern Europe in terms of growth. Do you think this is because countries in southern Europe have made the right decisions in the past few years?

One way of thinking about Europe is from a north-south perspective, but it is also important to consider it from an east-west perspective. This is because the countries that are immediate neighbours of Ukraine have been more exposed to the war than the west of Europe, particularly to the rise in energy prices. Another important aspect is the impact of the pandemic. Tourism was hit hard in 2020, so there has been a large margin for growth from very low levels. We should also give credit to the solidarity shown in the European Union with the Next Generation EU funding, which is very much geared towards countries in southern Europe. All of this should be recognised. In any case, I think that after the euro area crisis 10 to 15 years ago, the decisions that southern European countries took to achieve sustainable economic growth and reduce risk in the banking system have also played a role.

Do you think that the third pillar of the banking union will someday become a reality?

I think the larger our external risks, the more important it is to have a strong internal union. So, progress towards banking union, capital markets union or the Single Market will only make us stronger. But the more people can see the value of integration, the more this will help make it a reality. This integration will also help us to navigate the major challenge of the green transition. We could have the funding to tackle the essential task of decarbonising the economy.

Is the ECB comfortable with the level of trust that people have in it?

The most important contribution that we can make is to ensure that inflation comes back to the two per cent target, while also maintaining good economic performance. Over the past two years, we have seen inflation come down from its peak at the end of 2022. Of course, we have also seen an extended period of economic stagnation in Europe, but the labour market has performed well and unemployment has remained relatively low. I think people have understood that there were a lot of different forces at play here. The origin of inflation was coming from the rise in energy prices, the rise in food prices, and from a lot of global factors. The job of the ECB is to bring it back down to two per cent in a timely manner. I think a lot of progress has been made on that. Most people in Europe are going to see their income levels improve owing to above-inflation increases in wages from employers or in minimum wages. Living standards are going to improve this year, and I think that is very important. We hope that we will also see a recovery in investment next year. Ultimately, the more we can go back to normal, to a stable situation, the more the levels of trust will improve.