Interview with Hospodárske Noviny

Interview with Luis de Guindos, Vice-President of the ECB, conducted by Mário Blaščák

5 February 2025

The ECB lowered its interest rates by 25 basis points last week. How low can rates go given the current inflation and growth outlook?

We have been very clear that we are not following any predetermined path and will decide meeting by meeting, based on the incoming economic data. This is because the level of uncertainty is huge. Now that we see inflation approaching our 2% target, we have been reducing the restriction of our monetary policy. How much lower rates will go depends on the data confirming that inflation is converging towards our target in a sustainable manner. We are confident that this will happen this year, but there are still a number of uncertainties, particularly surrounding the geopolitical situation, that we need to take into account. So, even if our current trajectory under the current circumstances is clear, nobody knows the level at which interest rates will end up.

At the press conference, ECB President Christine Lagarde described the current level of interest rates as being in restrictive territory. Národná banka Slovenska Governor Peter Kažimír recently suggested that rates would decline to a neutral level close to 2%. Do you agree?

I usually agree with my friend Peter Kažimír on a lot of things [laughs]. The neutral rate is an interesting concept from an academic standpoint. However, using it as a reference for monetary policy decisions is not the right approach, in my view. The range of the neutral rate, based on different models, can be very ample. Our bank lending surveys provide a much better indicator of the restrictiveness of our monetary policy, by showing how banks are easing or tightening financing conditions. For policy decisions we need to consider all relevant incoming data and a vast range of indicators to form our assessment of the inflation outlook, underlying inflation and the strength of monetary policy transmission. So while the neutral rate makes for an interesting academic concept, it is not very useful from a policymaking standpoint.

Why don’t academic concepts hold up? Are we living through unusual times?

Academic research is crucial for the conceptual framework of the things we do. But the high level of uncertainty we are now dealing with potentially calls for a more pragmatic approach, placing less weight on unobservable variables or model-based estimates with shortcomings and results expressed in wide ranges.

Services inflation is double the target level and wage growth is near 5%. How confident are you that the projected moderation in inflation will actually materialise?

As we can clearly see at the moment, not all the components of inflation evolve in parallel. You are right that while goods inflation stands at 0.5%, services inflation is at 4%. It is important that services inflation starts to decelerate. We believe this will happen because services are very wage-sensitive, and we expect wage growth to start to decelerate. We also see our corporate surveys confirming our belief that wage dynamics will start to slow down, so we expect this to help bring down services inflation.

How is inflation expected to evolve over the next few months?

On average, we may see an increase in headline inflation over the next couple of months because of base effects, mostly due to energy prices. Nevertheless, we are convinced that headline inflation will start to decelerate later on in the spring and converge towards our 2% target on a sustainable basis.

Is there any time lag between the projected moderation in wage growth and services inflation?

There is always a certain delay in that respect. But looking only at wage growth data is like looking into a rear-view mirror. Looking ahead, we pay attention to expectations about inflation, which are firmly anchored. At the same time, there is the crucial “catch-up” process, which is almost complete. While the purchasing power of workers’ wages in the euro area fell during the period of high inflation, it has now recovered. These two elements lead us to believe that wage increases will start to decelerate.

Eurostat released data on GDP growth in the euro area, which has been stagnating. Forward-looking indicators point to an economic slowdown, affecting wages and, in turn, consumer demand. Is that the reason why you are expecting weak growth in household consumption?

You raised a very important issue. In order to understand what will happen to the economy, consumer behaviour is key. Right now, we don’t see consumption picking up even though the moderation in inflation has restored households’ purchasing power. It is likely that this is related to consumer confidence. The impact of past shocks like the pandemic, the post-pandemic period and the energy shock, as well as the current geopolitical situation and the general level of uncertainty worldwide, is moderating consumption. But we believe that confidence will be restored over time, as real wages recover.

A recovery in consumption will be key for a rebound of euro area economic growth. The lack of consumer confidence is one of the reasons why this has not been the case yet.

What would happen if the war in Ukraine were to end tomorrow? Would it change everything we think about the economy and the course of monetary policy?

From a human standpoint, a peace agreement would obviously be very positive. And generally speaking, an end to the war would also benefit the economy. But this would depend on how the war is resolved and whether the terms of the settlement are good for Ukraine and for the rest of Europe.

In its pursuit of price stability, the ECB targets inflation, but what role did weak economic growth play in your decision to lower interest rates?

Even though we target inflation, our decision-making of course involves a broader perspective. We consider a wide range of indicators, such as consumer demand, investment, energy prices and exchange rate developments, as well as actual and potential economic growth. We calibrate all of these components on an ongoing basis to produce the most accurate projection of inflation over time in order to support our decisions.

Slovakia is an automotive power. However, the car sector has been struggling in the wake of the green transition. After your dinner with European Commission President Ursula von der Leyen last week, how do you see the green transition evolving?

This question would be better put to the European Commission. Ms von der Leyen explained the main features of the Competitiveness Compass, with simplification and flexibility being major drivers. This means looking at decarbonisation targets also through the lens of the competitiveness of European industries.

Slovakia is one of Europe’s fiscal sinners, but it has implemented consolidation measures, including income tax and VAT hikes and the introduction of a transaction tax. Do you think it will be enough if small euro area countries take action while large countries do not?

Every country needs to do their part to comply with the new fiscal framework. The new rules need to be implemented fully, faithfully and by all countries, because the credibility of fiscal policy is crucial. This does not apply to Europe alone, but to other countries in the world too. Markets are monitoring each country’s fiscal position very closely, and any doubts about the sustainability of public finances are quickly reflected in increased government bond yields, as we have seen in the United States and the United Kingdom. An increase in government bond yields is detrimental to growth and financial stability. That is why we must maintain the credibility of the new fiscal framework, as this a prerequsite for keeping long-term yields at a low level, which is vital for the economic recovery. The new fiscal rules are flexible to allow sustainable deficit cuts and they will not jeopardise efforts to invest in areas such as climate change or defence.

Global debt is on track to hit 100% of world GDP this year. Is this alarming? And who is the biggest debt sinner?

I won’t name any countries, because the figures are already out there. In general, the policy response to the pandemic played a big part in increasing sovereign debt, as there was a combination of very loose fiscal and monetary policy. But this was an exceptional situation – extraordinary times require extraordinary measures.

That being said, many countries have seen their fiscal positions deteriorate. Public debt ratios are now high, and a number of countries have increased their structural deficits. This is why it is so important to implement the new fiscal governance framework in its entirety. This means not only reducing the fiscal deficit and the public debt-to-GDP ratio, but also implementing structural reforms.

Do you view the consolidation measures adopted by the Slovak Government as positive?

It is not for us to assess the fiscal measures of individual countries. Looking at Slovakia’s fiscal profile, we see that its debt is below the euro area average, at around 60% of GDP. The budget deficit is higher, which means that Slovakia is subject to an excessive deficit procedure. In general, it’s important to reduce the deficit in a way that ensures the sustainability of public finances. This can be done through a combination of cutting expenditure and increasing tax revenue. But how to do that, and by how much, is for each country to decide.

12 years ago, Italy’s fiscal sustainability triggered a crisis. Today, France is under the spotlight of the markets and its government bond yields are on the rise. Does this pose a threat to the stability of the euro area?

We have seen an increase in yields in several countries. In the case of France, this may have been somewhat stronger, mainly because of the political situation. But the plans submitted to the European Commission are fully compliant with the new fiscal framework. So what I hope for France, and for other euro area countries, is political stability, and for them to be able to implement the plans approved by the European Commission.

Mortgages are very important for people in Slovakia, as Slovaks prefer to live in their own homes. But interest rates went from levels below 1% all the way up to 5.3% in November 2023. In view of the monetary policy easing cycle, is the ECB a messenger of good news for Slovaks?

We are trying to do our job. When inflation was high, we increased interest rates, and now that it is falling, we are reducing them. On average, inflation peaked at above 10% in October 2022 and it now stands at 2.5%, which is why we have cut interest rates by 125 basis points since June last year. This has an impact on financing conditions and on mortgage rates, but the structure of the mortgage market is also important in determining how quickly our monetary policy is transmitted. In countries where most of the mortgage market is at variable rates, interest rate cuts are rapidly reflected in household mortgage payments. In countries where there are more fixed-rate mortgages, this process is slower. But the transmission of monetary policy easing will eventually be reflected in mortgages across the board, and people will feel that they are less costly than before we started to reduce rates.

So monetary policy is a bit of a bittersweet symphony? Bitter in bad times and sweet in good times?

Yes, bitter when inflation is high and we need to tighten financing conditions, and sweet when it is low. Now that inflation is declining, and if it continues to do so, we will adjust our monetary policy accordingly. If inflation had not declined, we would not have cut rates.

How big a threat are Donald Trump’s economic policies to the ECB’s inflation target?

With regard to tariffs, our analyses suggest that the main impact will be on growth. If the world embarks on the path towards a trade war, this will have an extremely negative impact on the growth prospects of the global economy. Increases in tariffs and quotas are a negative supply shock, especially if accompanied by retaliation. This vicious circle should be avoided. Estimating the impact on inflation is more difficult owing to the dampening effect of tariffs on demand and growth, as well as the fact that selective tariffs can lead to trade being redirected and diverted.

Are you concerned about stagflation, i.e. a stagnation in growth accompanied by rising prices, which the ECB’s monetary policy cannot reach? Could it lead to a reversal of the monetary policy stance?

If inflation moves according to our projections, the path of our monetary policy is clear. Although there are always some external factors affecting the economy, and potentially shocks, our baseline scenario sees inflation on track to converge towards our target this year, with a slight recovery in economic growth. We expect euro area GDP growth to reach 1.1% this year, following 0.7% last year.

To support the economic recovery, we will need a growth-oriented fiscal policy that also guarantees the fiscal sustainability of public finances, as well as structural reforms. This is where the European Commission’s Competitiveness Compass will play a key role. To achieve real unity, we need to simplify processes and integrate markets in Europe. That means the Single Market, the capital markets union and the banking union. These will be key elements in improving the growth prospects and growth potential of the euro area.