Interview with Expansión, Handelsblatt, Il Sole 24 Ore and Les Echos

Interview with Christine Lagarde, President of the ECB, conducted by Andrés Stumpf, Stefan Reccius, Isabella Bufacchi, Guillaume Benoit and Alexandre Counis in Paris on 7 June 2024

11 June 2024

What lessons do you draw from the restrictive monetary policy cycle that’s just finishing? You said you wouldn’t say the ECB is in a cutting cycle. But could the ECB stop after just one cut without raising credibility concerns?

First of all, we haven’t finished the restrictive monetary policy cycle yet. If you look at real interest rates, we’re still in restrictive territory and we have to continue as long as necessary to return inflation to 2%. There are different phases of a monetary policy cycle. The first one was a rapid and vigorous tightening: 450 basis points in little more than a year, during which we divided inflation by half, from 10.6% down to 5.2%. Then we went into the holding phase. This lasted nine months, taking inflation from 5.2% to 2.6%. Especially in the last part of that holding period, we said that we’d need to have enough confidence in the disinflationary path.

And what brought you to your decision last week?

We looked at all sorts of data, including some recent numbers which could have been better, and also our revised staff projections. We felt that disinflation was sufficiently advanced and would continue to progress over the next 18 months, and so we could cut rates. But we’re not on a predetermined path. At every step of the way, not only when we have new projections, we will reassess.

Which means?

We’ve made the appropriate decision, but it doesn’t mean interest rates are on a linear declining path. There might be periods where we hold rates again.

Do you mean you’ll need new figures, new forecasts, to take your decisions?

We will need more data, including on wages, on how unit profits are growing and absorbing part of the labour costs, and on productivity. Those are important drivers of services inflation, which is our weak spot.

And could those periods of holding be longer than a single meeting?

It’s a possibility. We need to see how labour costs evolve. And we need to see profits continuing to absorb those increases that are already there. Looking at our wage tracker, we know where that’s heading, but there might be bumps on the road.

The decision to cut rates was almost unanimous. But from the tone of the different members of the Governing Council, it doesn’t seem as if it’s going to be like that from now on. How are you going to deal with different opinions? Will you wait until there are large majorities before taking any decision?

Ever since I started my mandate four and a half years ago, I’ve tried to listen to everyone, to respect the views of all Governing Council members and to share information as much as possible – and I’ll continue doing that. It has paid off well so far. We’ve taken decisions in the past where there wasn’t unanimity. We’ve never had to take votes, although sometimes I went around the table to ask “are you in?”

Is the lack of guidance on rates going forward testament to the strong disagreement in the Governing Council?

Absolutely not. If it’s a testament to anything, it’s a testament to my personal view, that I hold strongly: that forward guidance has not been helpful. It may have helped when interest rates were close to the lower bound and we were conducting quantitative easing. But time-dependent guidance is currently not helpful.

So do markets have to get used to this new era where there is no guidance?

How can you give forward guidance when there is a very high level of uncertainty? Then you’re tying your hands – and in the meantime there’s wind and waves all over the boat and you can’t bring the sail in. We all agree that there’s huge uncertainty and there’s general agreement that, given the situation, forward guidance is not going to help us.

Let’s go back for a moment to the point you raised that the latest numbers could have been better. Wage growth has accelerated and inflation has risen for the first time this year. So why declare victory now, at this point?

We’re not declaring victory yet and we’re not mistaking the forest for the trees – English has a lovely way to say it. Last September we decided to hike for the last time and then we held. In our staff projections, we carefully check when we expect to reach our target of 2%. In September, December, March and June we had projections of either 2% or 1.9% inflation at a point in 2025. So there is robustness – we are expecting to get to our target in 2025. We know there will be bumps on the road.

Isn’t it bad timing to simultaneously have a revision in the inflation projection and the first rate cut?

The destination is 2%. We took a reasoned view of where we were in the cycle and by how much we had reduced inflation. We tried to assess what additional bumps we would hit, and on that basis we decided to cut.

You talked about how high uncertainty is and the need to be cautious, but you’re still running two risks – the risk of easing too quickly, with its implications for inflation and growth, and the risk of having a monetary policy that’s excessively tight, or tight for too long. The sentence “it would be appropriate to reduce the current level of monetary policy restriction” is not there anymore in your monetary policy statement. Why?

We started with the fact that, despite the interest rate cut, we needed to continue to be restrictive. Removing the easing bias was dictated by our wanting to be data dependent, with a real understanding of where we are heading and when we will reach 2%.

Which risk would you rather run?

I want to get to our target of 2%. We will have to constantly assess the risks and make the right decision at the right time.

I know you don’t give forward guidance for rates, but when do you think it will be appropriate to discuss the “natural” rate of interest, because we will get to that discussion, right?

Yes, I’m sure we will. But it’s very premature to start that discussion now. The natural rate of interest is likely to be higher than before the pandemic, but we are currently still far away from it. So I think it's pointless to start discussing that now.

Why do you think projections are more reliable than they were two years ago?

If you look at the magnitude of errors, it is significantly less than it was. Nobody likes to be wrong. The ECB teams were the first ones in the central banking world to look at where the errors came from. It was vastly because of energy prices and the failure to correctly assess where they were headed, which is hardly surprising given the magnitude of the risks and the speed at which prices moved. And there is an indirect effect as well, that filters into other variables.

You also raised the growth forecast for the euro area, so would you say the economy has finally turned a corner and gained growth momentum?

The growth outlook has improved and we could see this in some of the numbers. It’s also evident in corporate telephone surveys at various levels of industry and services.

Unemployment is down, employment is up. Salaries are up and there’s growth at a time when inflation is coming down. The saving rate is still very high, but people are spending more. In investment, we’re also seeing some pick-up. Not very strong, but it’s coming. The construction sector, thanks to a mild winter this year, has continued working, including in Germany. And financing costs have begun to edge down. So those are examples where I think that the economy is going to strengthen.

Why do you expect profit margins to compress when higher growth actually gives firms more leverage to raise prices, more pricing power, and not less?

As indicated in our policy statement, this is indeed one of the potential upside risks to inflation.

There are some countries with high indebtedness. And with the pandemic emergency bond-buying programme (PEPP) and the older asset purchase programme (APP) fading, these countries might come back into investors’ sights in the absence of any tools to react except the ECB’s Transmission Protection Instrument (TPI). But to activate the TPI, the country must abide by the fiscal rules of the European Union. Don’t you feel that we’ll be in a situation where you can’t really act because there’s too much debt, not enough fiscal orthodoxy and you’re blocked?

It was sometimes believed that TPI would only work if a country wasn’t in an excessive deficit procedure. That’s not the case. A country can be required by the European Commission to do a number of things in order to get back onto the right track – to bring debt down while preserving investment conducive to growth. It’s an incentive for countries to comply with the new fiscal framework, which allows for investments conducive to growth and productivity. If that framework is respected, then TPI operates and the country is eligible.

And aren’t you afraid that there may be some market moves after the end of the PEPP investments?

Our policy on the PEPP has been explained ad nauseam. Everybody knows we’re reducing the holdings over the second half of the year by €7.5 billion per month on average, and that we intend to discontinue reinvestments at the end of 2024. The gradual reduction of the APP has already proceeded smoothly. The PEPP announcement has been smoothly absorbed as well.

Still, it will be a major break for financial markets because there has been some support for bond purchases for 10 years.

Look at the footprint that we have in the markets. The ECB had been expanding its footprint and now we are gradually reducing it.

So the stability of the euro area will only be tested gradually?

As the situation improves, as the frameworks are put in place, as countries conform to the agreements that they have made with each other, the European Union and the euro area should continue to prosper.

I’m very curious to know what your role in the TPI was? It’s a very strong instrument and my personal opinion is that you were able to go much further than Mario Draghi, because he made the APP but you made the PEPP, and also the PEPP flexibility is very strong.

Mario Draghi set up the Outright Monetary Transactions instrument, also known as OMT, which was the outcome of “whatever it takes”. The TPI is a different instrument, not predicated on a European Stability Mechanism programme subject to certain criteria.

Also, when we launched the PEPP we said that we could deviate from the capital key if and when necessary. And markets got the message.

What about the TPI?

On the TPI, I don’t want to overplay what I did. But it was in strange circumstances because we were pressed for time. We had seen some movements in the spread between Italian government bonds and German Bunds that were not based on fundamentals. So we were beginning to work on these issues and it was finalised, from my personal vantage point, in a windowless and dark basement in a hotel in London.

By that time we had WebEx, Zoom, Teams, etc., which we didn’t have when we put in place the PEPP. I decided on the PEPP together with my colleagues from the Governing Council in a telephone conference that I chaired from my kitchen, and we only had the documents on iPhones and iPads. Fabio Panetta joined me and brought some cakes, because he was on the Executive Board at the time and living in the same area, and he thought it was going to be a hard night. We kept eating the cake until four in the morning. But for the TPI I called the meeting while I was in London for an event. I didn’t have a signal in the room so I said, “Can I go downstairs?” and the hotel staff said “Yes, you can, but there is an annual meeting”. I explained “That’s not going to be great, I need a bit more privacy.” And that’s how I ended up in the basement – in this dark place where they installed a screen.

On the one hand, we have 11 out of 20 countries on the verge of breaking the newly agreed euro area fiscal rules. On the other hand, we have Germany, clinging to its debt brake, holding back investments and dampening growth by doing so. Which is more of a concern to you?

The real concern I have is that this framework, that was laboriously agreed, is actually implemented and respected. All the small Member States have a vivid memory of earlier days when the big Member States ignored the rules. I very much hope, no matter how big or how small countries are, that all Member States play by the rules – because that’s the foundation.

Should Germany do more to support growth in the euro area?

It’s not for me to recommend fiscal policies. I would simply observe that significant investment is also needed in Germany.

You’ve called for expediting the capital markets union. Do you think it can happen quickly? What can the ECB do to help?

I very strongly believe in the necessity of a capital markets union. We really need to move fast from the top down and have a comprehensive approach. Certainly at the European Council level, there is momentum and there is an agreement that we have to be able to raise more capital in Europe in a more harmonised way. And there’s consensus that we have to keep a lot of Europe’s savings in Europe. There’s also consensus that we have to make massive investments in Europe. Enrico Letta referred to this in his report and Mario Draghi will say it too. Having single supervision is one condition, having a single rulebook is indispensable and having unified post-market infrastructure – all of that is necessary. We will do everything we can to help. It’s not our direct responsibility – our responsibility is price stability. But if we can combine forces and help, we will do so.

Do you think this is enough? The diagnostics are shared, there are some tools on the table and there is momentum, but is there something that could be done in the next couple of months rather than years?

Months? I don’t think so, because having a single rulebook is going to take time. The relevant question is how do we keep momentum? A revised securitisation framework might be a good starting point.

Given that nothing will be fast-tracked in that area, is there a need for a Next Generation EU (NGEU) 2.0, a successor to the EU’s economic recovery programme, beyond 2026?

That’s a discussion that has a political dimension – and that’s not the territory in which I have competence.

Is NGEU a success in your eyes? Some say that the US Inflation Reduction Act is powerful on the ground and NGEU is not.

We will find out in 2026, because only a small part of the NGEU funds has been released. Two things will matter: first, what has been concluded by the end of 2026 and, second – which should be discussed pretty soon – what the internal resources will be, that are to be decided on at the collective level and that will need to be paid back. Part of NGEU was grants and part of it was loans which will have to be refunded, and that part has not yet been entirely decided. It has certainly been helpful. And from a governance point of view it was a watershed moment. But has it been successful? It is too early to say.

It’s rare for the ECB to cut rates before the Federal Reserve. Against this background, how important is what you decided last week?

There have been instances in the past where the ECB and the Federal Reserve didn’t act in tandem. We each have to work on the basis of our respective mandates, and we have different fundamentals at the moment. If you look at activity, if you look at the labour market, activity is stronger in the United States. Demand there is stronger and has fuelled inflation much more than in the euro area. The US labour market is also different because it’s probably tighter than ours. We each have to respond on the basis of our respective economies. But we do take into account the spillover effects.

There has not yet been an appointment of a successor to Bank of Spain Governor Pablo Hernández de Cos. Does this worry you at all? There is also a possibility that he will be replaced by a woman, which would be a huge advance because it would be the second national central bank in the euro area to have a female governor.

Pablo has been a fantastic team player and a class act. Caballero, I call him. We will all miss him and I will miss him. He is a very thorough economist and central bank governor, and he was also a very loyal team player. He is really a great man to work with. His contribution to the Governing Council was always very strong, highly appreciated and very respected. I hope very much that the Spanish Government appoints somebody who will deliver the same level of contribution.

Will European citizens have access to a digital euro by the time you leave office in 2027?

Possibly, though that would be an accelerated process. We are not the only ones working on this. The European Commission and the European Parliament will be critical, as they will give us the legal framework within which a digital euro would be issued. We’re doing as much as we can on the technical work, but the legal framework will be needed for us to move forward.

Is the ultimate goal to have the ECB issue a digital euro?

My ultimate goal is 2% inflation. That’s what I’m obsessed with. But I also want to make sure that the ECB is fit for the future. And if the preference of Europeans follows the digital route that we observe, I think it’s really important to have some central bank money in a digital form and accessible to all those who want to use it.

And finally, what is your take on the outcome of the European elections? *

The ECB is an independent central bank and that means we’ll deliver on our mandate no matter what the outcome of political elections. We are prepared to work with the newly elected European Parliament.

* This question and answer were added after the European parliament elections