Interview with Expresso

Interview with Luis de Guindos, Vice-President of the ECB, conducted by Gonçalo Almeida on 13 September

20 September 2024

Two years ago when the ECB started raising interest rates, you told Expresso that you didn’t know how high they could go. Did you at any point think they would reach the level they have?

Talking about the past is always much easier than talking about the future. Two years ago inflation was very high. We have to remember that it was in the region of 10%. At its peak, we had to tighten our monetary policy quite a lot. But now I think good news has started to emerge as inflation, which is currently slightly above the 2% mark, falls. We have already cut rates twice, by 25 basis points each time, and I think that the main message we now want to convey is that inflation is getting closer to our 2% target and we expect it to reach the target at the end of 2025.

The markets are now predicting that there will be a cut at each ECB meeting between now and the end of the year. Is this a possibility?

We are fully committed to our mandate and data-dependent, taking a meeting-by-meeting approach, and this will depend on the evolution of the whole set of data that we will receive. We will hold two monetary policy Governing Council meetings in October and December. It’s true to say that in December, we will have more information than in October. We will have more information and a new round of projections. But, you know, we have left the door totally open. We want to maintain our optionality, and that will depend on the evolution of the data. It is quite clear – and I think that this is relevant – that the September inflation data is expected to look very positive due to base effects, but at the same time, in the last quarter of the year inflation will go up because of base effects. So these are factors that we need to take into consideration. But, and I repeat: we are keeping all of our options open.

In the new September macroeconomic projections, economic growth for the euro area has been revised down. Do you think the ECB has been on a restrictive path for too long?

I think we need to look at inflation and how it evolves. As I mentioned earlier, this has been quite positive and we are currently on our way to reaching our target at the end of 2025. But I think the reasons behind the evolution of growth in European economies have much more to do with other factors. It’s true that we revised down our growth projection, but it was a marginal reduction of only 0.1 percentage points. However, we also stated something quite important: we believe that the risks to growth are tilted to the downside. Our growth projection hinges on two main elements. The first is that consumption is going to recover, and the second is that there will be an increase in net exports.

Will consumption be a fundamental factor?

I think the main factor will be the evolution of consumption. We believe that with the drop in inflation, households’ real incomes will go up, which will lead to an increase in their purchasing power. The labour market evolution is positive, which means that consumption will begin to increase over time. But there are other factors at play, such as consumer confidence. Even though real incomes improve, consumers may feel that other factors are undermining their confidence, such as political risks or other things that we can’t control. Having said that, we expect that the economic recovery will be based on consumption and the recovery in the purchasing power of households.

But the ECB also revised down its growth projection for private consumption for the next three years. What impact will this have on firms, particularly in the services sector? Is the Volkswagen case an example of the challenges that lie ahead?

I think the Volkswagen case is a very specific and particular case. It’s going to be very important that we start to see a recovery in consumption. As I already said, this will be the main driver of the economic recovery. I am fully convinced that the disposable income of households in Europe will increase on average. But there are other factors at play, because consumption does not only respond to income in the short term. I think consumers need to see what economists refer to as an improvement in their permanent income, their long-term income. And that is very closely related to sentiment and confidence. At the moment, there is an extremely high level of uncertainty, and that’s what is dampening consumer behaviour. But I believe the conditions are in place for an improvement in consumption in the short term, although there are other factors over which we have no control. It is mainly confidence that will be a key determinant of consumer behaviour. This is the main risk we have identified.

Even though the ECB started to raise interest rates in July 2022, consumer loans have continued to rise in the euro area, especially in Portugal, year on year. In spite of the adverse lending conditions, people continue to take on debt to pay for holidays or buy a car. Do you think this is dangerous?

It is absolutely true that there has been an increase in consumer credit in general. However, on the whole I feel that this increase has been relatively moderate. If you look at the aggregate data, you can see that the evolution in loans to households is relatively contained and close to zero. This is one of the reasons why we have said that monetary policy is working.

Let’s look now at services inflation, which is driven by consumption. Services inflation accounts for almost half of headline inflation. Why hasn’t the ECB been able to control this component of inflation?

Services inflation is the weak spot of inflation, both now and in the future. I think we have to take several factors into consideration: first of all, the demand for services can be much stronger than the demand for goods. Second, and most relevant: services are very sensitive to the evolution of labour costs. We have seen that wage dynamics have been quite elevated. There is some moderation now, but wages, or compensation per employee, have been growing at a rate of over 4%. Simultaneously, there is another factor, productivity, which has been close to zero. Consequently, unit labour costs have been rising. The services sector is particularly sensitive to the evolution of unit labour costs and we believe that inflation in the sector will start to fall because we are expecting a moderation in wage agreements and in compensation per employee alongside a simultaneous, significant improvement in productivity. I think that the main risk factor is pressure on costs in the services sector.

And Portugal is one of the euro area countries that has seen the highest growth in real wages since the year before the pandemic...

Recently wages have been catching up with inflation over the past few months. At the beginning, the increase in inflation was significantly higher than the increase in wages, but of course workers reacted, and now a process of catch-up is under way, which is normal and appropriate. In my view, wages have to catch up prudently and gradually with inflation. At the same time, we need to see an improvement in productivity. The process of absorbing the increases in labour costs through firms’ profits cannot go on forever. As I said earlier, our projections show that wage dynamics will start to moderate. We believe that in 2025 there will be a clear moderation in wage increases. But it will be crucial to see productivity recover, and there is still a big question mark about this.

Do you think that the worst of economic tightening is already over for families or do you think it will be felt in the coming months?

We have started to ease our restrictive monetary policy. In countries like Portugal, where most bank loans are variable rate loans, the fall in interest rates will quickly be felt in repayments due. Over time, something similar will happen in Spain. In other countries where there is a higher percentage of fixed rate loans, the impact will take longer to feed through.

At the last ECB Forum in Sintra, Christine Lagarde expressed concern about the debt levels in euro area countries. The plan presented by Mario Draghi in recent days was highly praised by the ECB President, but it is predicated on the issuance of more debt. Isn’t that a contradiction?

No. First, we believe that the plan is good and the diagnosis is correct. The most important part of the plan is the recommendations for structural reforms. The figure of €800 billion is used as an illustration, so as to throw into yet starker relief the gap in terms of investment between Europe and the United States. It is a way to show the effort that will be required in terms of public and private investment. There are recommendations for ten sectors and I believe that this is the part that we need to analyse with closer scrutiny because it very clearly sets out the future agenda for the Union’s economic policy. This €800 billion reveals the wide gaps that have to be eliminated by means of a reformist agenda. This is the responsibility of governments rather than the ECB. And I am convinced that if the policies proposed in the plan were implemented, this figure could be lower.

Turning to the banking sector, interest rates on deposits with commercial banks have been falling for eight months in the euro area, and Portugal has the fifth-lowest interest rates. When the ECB was putting up rates, do you think that the commercial banks could have done more to encourage households to save?

When the transmission of monetary policy is effective, increases or cuts in interest rates should affect both borrowers and savers. Lending rates and the remuneration of deposits are expected to reflect our interest rates. At present, the cost of loans is starting to decrease and banks’ margins should start to decline.

Do you think that Portugal should tax banks’ windfall profits, as is the case for other sectors?

The improvement in the profitability of European banks was a temporary circumstance. We have already started to see a stabilisation and we project that it will start to decline. So banks and investors should not view this improvement as guaranteed or permanent. It will not be long-lasting.

The market value of the US company JP Morgan is greater than the combined value of the ten largest European banks. Is consolidation in the European banking sector essential for its survival?

I believe that consolidation is an important element. However, the contrast between the valuations of European and US banks is a sign of the potential problems that we face. I think that one reason for this is the lack of full banking union, as well as the national approaches that still exist in the banking sector. Because of this, investors regard US banks as having higher intrinsic value than European banks. In this context, cross-border consolidation is important and we hope that it continues to make progress in the near term.

Including in Portugal?

The Portuguese banks are performing quite well. Overall conditions are favourable. An analysis of the shareholding structure reveals that some are owned by foreign investors and others by foreign banks. There are always challenges ahead, but the banks are sound and resilient.

Over the last decade the ECB kept policy rates practically at 0% or negative levels. Is there any scenario in which rates could return to that level at some point in the future?

The future is a very long time [laughs]. But if we look at the short and medium term, at the next two or three years, I don’t believe so. That was an extraordinary situation. Zero or negative policy rates were due to a very specific situation and I don’t think we will see them again in the near future.

And do you think that keeping rates at that level for so many years caused any market distortion?

Whenever an economic policy decision is taken, there are pros and cons. No decision is without both pros and cons. Ultimately, the decision taken had more advantages than disadvantages. Remember that inflation was not a concern and the main risk was deflation at that time. Deflation was linked to structural issues such as globalisation, population ageing, GDP developments and competitiveness. The current situation is a little different. The globalisation process is changing and, while we are not entering into a process of total fragmentation, we will not go back to how things were before. This is an important structural component that will have a bearing on inflation and economic growth over the coming years.

But this policy makes all investments seem attractive compared with bank deposits, creating strong pressure in the property market. Was it in some way one of the triggers for the housing crisis that we are experiencing today throughout Europe?

Currently we have a different paradigm. First of all, we don’t have a housing bubble like we did 15 years ago, although prices have risen. There are real factors beyond monetary policy decisions that affect housing market developments. This is a significant problem, especially for young people. The issue of affordable housing is not just a problem for Portugal but also for Spain and other countries. We should consider policies that boost and foster the building of affordable housing and create an efficient rental market. While we can recall the consequences of the previous housing bubble, the current problem is the shortage of affordable housing, and it is important to recognise that monetary policy is not the main factor behind this.

And do you regard the Portuguese Government’s current measure of subsidising house purchases by young people to be a problem for the market?

There is a real problem here: young people are not able to buy or rent a home. This has broader implications, at both the economic level and the social level, affecting how the economy is generally perceived. To solve this problem it is essential to combine two elements that governments should seek to implement. First, it is crucial to promote the building of affordable housing, both to buy and to rent, since all the markets are interconnected. And in the short term if there are specific segments of the population who are unable to buy or rent a home, a temporary subsidy could be a solution that should be considered.

José Luis Escrivá’s move from the Government straight to the Banco de España has been heavily criticised. From your experience, since you also left the Spanish Government to join the European Central Bank, can the walls of a central bank be immune to political power?

First, I would like to say that the appointment of the governors of national central banks is the responsibility of governments and we don’t carry out any assessment of national policies. The process for appointing members of the ECB’s Executive Board is different. Members are appointed by the European Council following a vote in the European Parliament. I believe that having a broader perspective on the functioning of the economy is sometimes a positive thing. In the case of Spain, the situation was a little more complicated because traditionally there is a consensus on the choice, but this time no consensus was reached.

Your term of office as Vice-President of the ECB ends in 2026. Do you already know who will replace you? Could Mário Centeno have a chance of taking your place, for example?

I don’t know [laughs]. I will have very little say in my replacement, as it will be decided by the European Council and the European Parliament. Mário is a great economist, an excellent governor and a good friend, but I don’t have any influence on the choice of my successor.