Interview with El Correo (Grupo Vocento)

Interview with Luis de Guindos, Vice-President of the ECB, conducted by Adolfo Lorente and Manu Álvarez on 26 April

1 May 2022

Will interest rates already rise in July?

It will depend on the data and the new macroeconomic projections in June. In April the ECB’s Governing Council decided that asset purchases will end in the third quarter. In my opinion, there’s no reason why this shouldn’t happen in July. Rates will rise after that. Exactly how long after has not been decided. It could be months, weeks or days. July is possible, but that’s not to say it’s likely.

We haven’t even had the first rate hike yet, but the market is already pricing in two rate hikes this year, and there’s even talk of a third. Are you under even more pressure to act?

We are driven by data, not by markets. Markets can sometimes be wrong. Within the Governing Council we haven’t discussed any predetermined path for rate rises.

Some economists are criticising you for acting excessively slowly.

These comments stem from the comparison with the United States, but the situation in Europe is different. There are two main factors that will determine interest rates. On the one hand, you have the evolution of second-round effects – in other words, wage increases that are incompatible with price stability. And on the other hand, you have inflation expectations, which we should monitor to make sure they don’t rise above our target of 2% over the medium term. So far, we haven’t seen wage increases that would put this target at risk, but we have to be very attentive because this is a delayed indicator.

Do you see any risk of a recession, even if just out of the corner of your eye?

The invasion of Ukraine will increase inflationary pressures and reduce economic growth. The fact that the prices of raw materials and energy have increased in the way they have implies, in practice, a tax on workers and companies, because these imported production factors are becoming more expensive. And, ultimately, this implies a decline in living standards. On the risk of recession – in June we will have new projections. What we are already seeing is a significant weakening of growth. Even so, in 2022 growth will be positive. And if we stick to the technical definition of a recession – two consecutive quarters of negative growth – we currently don’t see it.

And one quarter?

Certainly not two.

But in the scenario in which Germany, under pressure from its partners, decides to cut off its supply of Russian gas, the impact on its economy could act as a very significant drag on the entire euro area.

One can always imagine worse scenarios. In the March projections with three scenarios: one baseline, one adverse and one that we call severe, we did not see a recession, not even in the severe scenario. Let´s wait for the June projections.

With the withdrawal of stimulus, are there countries that may experience problems related to funding or their budget deficit?

Nominal rates for public debt have increased all over the world, but risk premia are still relatively stable. The risk of fragmentation has not materialised, but it’s something we are monitoring. We currently don’t see any tensions in this respect, and the situation is in no way comparable to 2011 and 2012.

Is Spain – the fourth largest economy in the euro area – ready to cope with a rate increase?

The Spanish economy has two strengths. First, the financial system is healthy, following the restructuring of the banking sector. This allowed banks to continue lending to firms and households under favourable conditions, even during the pandemic. And second, the Spanish economy is competitive, as the balance of payments of its current account remains in surplus. This has been the case since 2013, even though it was previously inconceivable.

And what are its weaknesses?

Again, there are two. The first is the fiscal situation. The debt-to-GDP ratio is close to 120% and the structural deficit is nearing 5%. In addition, both headline and underlying inflation in Spain are back above the European average. And as Banco de España has warned, corporate margins are starting to be significantly affected, as the profitability of Spanish firms is falling because of the rising costs of energy and commodities. This factor has to be carefully considered.

Would you advise the Spanish Government to start taking seriously the need for increased budgetary stability?

My recommendation – and this is not only for Spain, but for all countries with a weaker fiscal profile – would be to present credible budget plans to Brussels. Plans that set out a prudent and sensible process of fiscal consolidation. With these levels of inflation, interest rates are not going to be as low as they have been in recent years, and governments need to prepare for this. The key, also from the markets’ perspective, is to have credible proposals.

There has been a lot of talk about the Spanish economy’s extreme dependence on the ECB. Beyond the literature, what is the true impact, in figures, of all the measures adopted?

There is one figure that is particularly indicative. During the pandemic, in 2020 and 2021, the ECB bought €120 billion of Spanish debt in the secondary market each year. This is equivalent to Spain’s total net issuance. European support, including via the Next Generation EU fund adopted by the European Council, has been crucial, especially for an economy like Spain’s. It was the Spanish economy that suffered the largest decline in 2020 and, despite strong growth of 5.1% in 2021, it was below the European average. And unlike the rest of Europe, income levels have not recovered to pre-pandemic levels.

Is it sustainable for a government to link pension increases to inflation by law?

Pension indexation is a social policy decision and it is not my place to question it. It’s a respectable decision, but it is also clear that it will have consequences for the sustainability of the system. So, such a decision needs to be accompanied by measures that ensure the system remains sustainable over the medium term.

And what about public sector wages?

I must stress that as Vice-President of the ECB, I cannot enter into the discussion of what a government or party says or does. In general, it’s necessary to be prudent when taking decisions. Sometimes the credibility conveyed by the measures is as important as the measures themselves.

As Banco de España defends, is this the time for wage restraint and for employers and unions to reach wage agreements?

The European and Spanish economies will face a complex situation, with high inflation, a downward trend in growth and smaller company margins. This will have an impact on investment and employment. In such a situation, where difficult decisions will have to be taken, it will be important to have the greatest possible social and political support for economic policy.

And do you think Spain is prepared politically to reach such agreements?

I have made a general remark. I can’t assess the situation of any specific country.

Another issue on the table – not only in Spain – is taxes. Is there any scope for reducing taxes in this crisis environment?

Not all countries are in the same situation. The public sector can play a role in cushioning the impact of the war on businesses and households. But this can also increase the budget deficit.

Some sectors criticise this theory because reducing taxes would further fuel inflationary pressures.

We are talking about temporary and selective measures that should be targeted at the most vulnerable sectors. If the measures are well designed, fiscal policy can help to lessen the impact of an external supply shock like the current one preventing those negative effects for inflation over the medium term. The pandemic affected lots of companies that are now being hit by a second shock. As I said, Spanish companies are seeing significant cuts to their margins.

At a time of uncertainty, the health of the financial sector is key. Do you think there are countries that still need to make an effort to recapitalise their banks?

Broadly speaking and judging by the capital and liquidity levels of European banks, we are in a much better situation than in the past. The pandemic crisis caused a great deal of concern about the potential impact on the financial system, but it has proven to be resilient.

So, you are completely calm when it comes to this matter…

There are still risks. Nominal interest rates are rising in the markets, which enables the banking sector to achieve higher profit margins. But it may also have an impact on non-performing loans. If they increase, bank profitability drops. And for the banks, customer creditworthiness is key.

Looking back, has progress in the Spanish banking sector been good enough? Would you have signed off on the current state of play when you were Minister for the Economy?

In 2011 and 2012 bank risk was a heavy burden that was dragging Spain into a very deep recession. There was a need to request the bank bailout, reform the old savings banks and create [the asset management company] Sareb, as there were more than €110 billion of irrecoverable loans to the real estate sector. In 2017 Banco Popular went into a liquidity crisis, which ended in the bank’s resolution. At that time, despite the size of the entity, there was no longer a contagion effect in the financial sector. So, after years of reforms, the situation in the banking sector was already very different. And today it is one of the strengths of the Spanish economy.

In the case of Banco Popular, would it have been possible to resolve it in just a few hours in 2011?

It would have been completely impossible.

Are the calls for mergers between financial institutions still on the table?

Yes. The European banking sector has a structural problem of low profitability, which it needs to address. Profitability has improved in recent months, but mainly due to the reduction of provisions. Now that we’re in an environment of lower economic growth, there will be a need to analyse whether that trend is sustainable over time or whether other measures are needed.

Do the ECB’s recommendations target domestic or cross-border mergers?

With 19 countries sharing a currency, in a single market and with a single banking supervisor, cross-border mergers would be ideal. Cross-border mergers are not straightforward because there are different regulatory systems and each country has its own unique features. But in a single European system, we should strive to have truly European banks. That being said, domestic mergers also serve their purpose as they can help to reduce excess capacity in some countries, keep costs down and increase bank profitability.

Kutxabank is continuing with its independence strategy.

I can’t comment on individual banks. As is widely known, Kutxabank is an entity with high levels of capital and liquidity which can play an important role in the banking sector in Spain and Europe.

This interview was published in El Correo, El Diario Vasco, El Diario Montañés, La Verdad, Ideal, Hoy, Sur, La Rioja, El Norte de Castilla, El Comercio, Las Provincias and La Voz de Cádiz (Spain).