The vice president of the European Central Bank (ECB), Luis de Guindos, has told Spanish newspaper ABC that "monetary policy measures are starting to have an impact on financing conditions," or in other words, recent ECB hikes in its base interest rates are starting to impact the rates paid by consumers and prompt people and businesses to take out less credit.
"The contraction in credit will pass through to the real economy," de Guindos said. "In turn, dampening demand will lower inflation."
De Guindos told the paper, in an interview the ECB itself shared via its own website in English and Spanish, that the ECB currently expected headline inflation to fall to 5.4% this year, 3% next year, and to be only slightly above the eurozone. target of 2% by 2025.
However, he also warned the underlying inflation — excluding core commodity prices like energy and food — was rising more sharply, "mainly driven by unit labor costs."
Energy and food prices are both well past the peaks seen during the initial shock following Russia's invasion of Ukraine and have been falling, very sharply in the case of energy prices, in recent months.
De Guindos described the European labor market as "robust," and said ECB data suggested the inflation was caused less by wage increases aiming to account for inflation, and more by a slowdown in productivity leading to increased labor costs for the same output. He did not speculate on possible reasons behind this.
The bank's deputy also said he believed that "the priority now is to bring down inflation," and that if that meant a mild recession or stifling economic growth, it would be a price worth paying given that "it is very difficult for economic growth and stability to co-exist with high inflation over time.
ECB vice president Luis de Guindos speaking in Madrid at a seminar. Archive image. ECB vice president Luis de Guindos speaking in Madrid at a seminar. Archive image.
Sidesteps questions on future interest rate moves
The ECB, like most western central banks, has been steadily raising its base interest rates — after a historically unprecedented 15-year period at or near 0% in the aftermath of the 2008 financial crash — over the past year or so.
It was criticized in some quarters in 2022 for being slower to react and start raising rates than the US Federal Reserve was; The Fed was able to halt its series of rates increases for the first time in a year this month, unlike the ECB.
The most recent ECB increase, earlier this week, raised its main refinancing operations rate — probably the most important of the three rates it sets for commercial banks — by 25 basis points to 4%.
The ECB has indicated that further increases in the course of the year are likely but without explicitly saying what or when, and de Guindos sidestepped the question in Sunday's interview as well.
"That will depend on the data," he said when asked whether to expect another increase during the summer holidays. So far, we have raised rates by 400 basis points and can already see the impact this is having, but we need to ensure that inflation converges and holds at around 2%, our price stability target. What happens with underlying inflation is paramount. "
Eurozone inflation differences 'arguably more marked now'
The ECB is an unusual if not unique central bank in that its policies apply to all members of the single European currency, the euro. Most central banks are responsible for a single country rather than sharing some of the responsibility for 20, although each eurozone member has its own domestic central bank too.
It has therefore always been a difficult balancing act for the ECB to try to take all its members' economic needs and desires into account. But de Guindos said that the conflict in Ukraine was contributing to more marked regional variations, with economies closest to the conflict impacting more.
"There have always been differences, but they are arguably more marked now. Proximity to war has a lot to do with this. Inflation is higher in the Baltic states," he said.
Don't forget pandemic response's impact, de Guindos warns
De Guindos told the paper that as well as Russia's invasion of Ukraine early last year, the consequences of two years of pandemic economic policy — marked by a vast uptick in government spending and borrowing, and a reduction in output, almost across the board — was playing a sizeable role on today's economics.
"The current inflation scenario cannot be understood without taking into account the wave of shocks that have hit Europe: the pandemic, the reopening of the economy and Russia's invasion of Ukraine. Without the expansionary monetary and fiscal policies of 2020 and 2021, the fall in GDP would have been far more pronounced. In such exceptional circumstances, we must adhere to the lesser evil principle. There is no one perfect measure to cover every economic parameter, so one has to choose the least harmful," he said.
Unsustainable debt and public spending the next stumbling block?
De Guindos said he supported efforts to start undoing some of the exceptional measures taken amid the pandemic and the subsequent energy crisis in a bid to reinstate in public borrowing. The European Commission recently called on member states to revisit the various energy price guarantees they implemented.
"Energy prices are lower than they were when the war started. The support measures adopted to shield the most vulnerable sectors made sense at the time, but now they need to be gradually rolled back. This will help correct the public deficit. Countervailing fiscal and Monetary policies, i.e. one that is expansionary, the other restrictive, should be avoided," he said.
If high levels of government borrowing were to continue, he said, that would continue driving inflation, and would most likely force the ECB to take even more sharp action on interest rates in a bid to counteract this.
ECB says lenders should increase deposit rates, not just loans
De Guindos was asked why the rates of commercial lenders then charged to consumers appeared to be changing for borrowers, and yet remaining at or near zero for depositors. He said this should not persist and that he believed it ultimately would not.
"When interest rates rise, they should rise across the board, on the assets and the liabilities side," he said. He added that he understood why "there is always greater resistance" from the general public to increased rates on loans or mortgages rather than savings.
He wouldn't be drawn on a question of whether the banking sector was guilty of "tacit collusion" on this issue, saying that was a question for industry regulators, not the ECB. However, he also pointed to a theory on why the rates might be slow to increase, but likely to do so in time:
"There is currently still excess liquidity in the market, which means there is not as much need for banks to compete to attract deposits. But this excess liquidity is being withdrawn, which will result in banks having to start competing with each other," de Guindo predicted.