Interview with Die Zeit

Are these tensions in the financial system the downside of the zero interest rate policy which central banks have been pursuing for so many years?

I don’t think that diagnosis is correct. The origin of the low interest rates was inflation that was too low, and the origin of the rising interest rates now is that inflation is too high. So I think what you described there is essentially a reflection of the actual issue, that inflation rose quickly. And it is clear as daylight that high inflation emerged because of the pandemic and because of the war in Ukraine. Of course, it is our job here at the ECB to make sure now that inflation comes down quickly to 2 per cent.

Inflation rose in 2021 and reached 5.1 per cent in January 2022 – before the war. So isn’t this development at least partly due to monetary policy?

No. Between summer 2021 and February 2022, when the invasion started, we had very strong goods inflation because of the pandemic and supply bottlenecks. Second, the European economy had just reopened after all the lockdowns. People were keen to go on holiday or were more relaxed about going to a restaurant and spending their money. Third, Russia had restricted energy supplies even before the invasion began. So we had three factors driving inflation at the beginning of 2022: bottlenecks, the war and energy prices, and the reopening of Europe. The inflation we’re seeing stemmed from these unusual factors. Finding the solution to that inflation, that’s our job.

You don’t see any misjudgement of the inflation by the ECB at that time?

Given the information we had at the time, I think we made reasonable choices. What is essential is that, if you see the world changing, you respond. We reduced the amount of money we put into the economy by buying bonds – from over one trillion euro in 2021 to net zero by June 2022. That was a huge turnaround. And many people predicted we would be reluctant to raise interest rates.

Weren’t you too reluctant? You only started raising interest rates in July.

Our priority in the first half of 2022 was to end this large bond-purchasing programme and start hiking rates afterwards. And the markets understood early on that we would raise our rates. For example, mortgage rates here in Germany also started to rise well before we began lifting our ECB rates. Thus the tightening has effectively been there since the end of 2021.

Let’s look forward. You predict that the inflation rate will go down rapidly from 10 per cent at the end of last year to 2.8 per cent at the end of this year and then further towards the inflation target of 2 per cent. Why you are so optimistic?

It’s a mix of factors. Energy prices are falling. Food prices are still very high and that is what people see when they go to the supermarket. But if you look at the earlier stages of production, at the farmgate prices, at the prices of the food ingredients, you will recognise: all of these have turned around. And history tells us that this will eventually lead to lower retail prices. Another factor: we have fewer supply bottlenecks. Car firms, for example, are able to get their microchips again. Therefore, the prices of goods should stabilise. Wages will rise on the other hand, but our overall assessment is a rapid decline of inflation at the end of this year.

Joachim Nagel, the president of the Bundesbank, warned recently that “price pressures are strong and broad-based across the economy”. How does that fit with your rosy outlook?

I agree with that statement. Our President, Christine Lagarde, said something similar. We are in fact probably in the most intense phase of inflation. It takes some time until the dynamics which I described reach the customer. Let’s say you’re a producer. You paid a high price last year for your inventory. When you sell these goods now, you’ll probably seek a correspondingly high price, even if your input purchase prices are already declining. So right now we still have this intense inflation pressure. Although, when you look further ahead, you see the improvement, gradual in spring and summer, but quite a bit in autumn.

Does this mean there is no need for more rate hikes?

Under our baseline scenario, in order to make sure inflation comes down to 2 per cent, more hikes will be needed. That is absolutely our diagnosis. If the financial stress we see is non-zero, but turns out to be still fairly limited, interest rates will still need to go up. However, if the financial stress we talked about becomes stronger, then we’ll have to see what’s appropriate.

So there is a trade-off between fighting inflation and stabilising banks?

No. If this financial stress weakens the economy, it would automatically reduce the inflationary pressures.

You mentioned rising wages. Do you see any sign of a wage-price spiral which could fuel inflation?

So far, rising wages have not been an important source of inflation. Last year a lot of the price increases could be put down to increased profits and rising energy costs. This year we think there’s a handover. We expect wages to go up more quickly as unions react to the high inflation of last year. But it’s very important for everyone – workers, firms – to recognise that inflation will be much closer to 2 per cent next year and in 2025. The wage-price spiral is a scenario which happened in the 1970s when expectations became entrenched that inflation would be high every year. This is not what we’re seeing. We’re seeing wage increases that are higher than normal, but in the grand scheme of things they look reasonably fair. But we have to keep an eye on this.

In Germany unions are demanding a pay rise of 10.5 per cent for the public sector. Could this trigger more inflation?

I’m not going to comment on any one particular set of negotiations. What I would say is, sometimes I read headlines of very high wage increases. But when you look at the details, there is often a one-off payment, which doesn’t increase labour costs permanently. Or the wage increase might be spread over 18 or 24 months. So the true increase per year is lower.

At what percentage does a wage increase start to get dangerous in terms of inflation?

Let me cite what we have in our forecast. Remember, under this forecast, inflation is coming down to 2.8 per cent at the end of this year and then continuing to improve towards our goal of 2 per cent. We assume wage growth of 5.3 per cent this year and 4.4 per cent next year. We’re putting a lot of effort into tracking wage settlements week-by-week, and so if we saw them coming in above that, then we would start to become more concerned.

ECB President Christine Lagarde said there should be a fair burden-sharing between employees and companies in this time of high inflation. What does that mean?

The spectacular rise in energy import prices was the trigger for high inflation. We’re paying more for imports of oil and gas from other countries now. Which means that there is less income to be distributed in our economy. There is a collective loss. And the question is: how much should the workers’ earnings go down and how much the profits of firms? The loss has to be absorbed somehow if we want the EU to remain competitive and to do well in global business.

Is the burden-sharing fair at the moment?

Well, profits did better than wages last year for a number of reasons. One reason, for example, is that wage negotiations take time. This year we expect wages to increase more. And we believe that firms will have less space to increase their profits through higher prices. For many reasons: demand should cool off and the supply bottlenecks should ease, for example. So the share of the burden changes over time.

But in general your outlook seems quite optimistic. You expect inflation to fall quickly while the economy grows. Does it mean we’re going to achieve a so-called “soft landing”?

It is possible. Some might object that it takes a recession to bring down inflation. But we have a very unusual situation. We’re coming out of a pandemic and out of a very severe energy crisis. We’ve lost so much growth momentum in the pandemic that it’s possible for the pandemic recovery to continue and for inflation to come down simultaneously.