Climate change is a global problem that needs global solutions. As the EU raises its own climate ambition, and as long as less stringent climate policies prevail in many non-EU countries, there is a risk of so-called ‘carbon leakage’. Carbon leakage occurs when companies based in the EU move carbon-intensive production abroad to countries where less stringent climate policies are in place than in the EU, or when EU products get replaced by more carbon-intensive imports.
The EU’s Carbon Border Adjustment Mechanism (CBAM) is our landmark tool to put a fair price on the carbon emitted during the production of carbon intensive goods that are entering the EU, and to encourage cleaner industrial production in non-EU countries. The gradual introduction of the CBAM is aligned with the phase-out of the allocation of free allowances under the EU Emissions Trading System (ETS) to support the decarbonisation of EU industry.
By confirming that a price has been paid for the embedded carbon emissions generated in the production of certain goods imported into the EU, the CBAM will ensure the carbon price of imports is equivalent to the carbon price of domestic production, and that the EU’s climate objectives are not undermined. The CBAM is designed to be compatible with WTO-rules.
Latest developments
On 13 December 2022, the Council and the European Parliament reached a political agreement on the implementation of the new CBAM.
Key elements
The CBAM will initially apply to imports of certain goods and selected precursors whose production is carbon intensive and at most significant risk of carbon leakage: cement, iron and steel, aluminium, fertilisers, electricity and hydrogen. With this enlarged scope, CBAM will eventually – when fully phased in – capture more than 50% of the emissions in ETS covered sectors. Under the political agreement, the CBAM will enter into force in its transitional phase as of 1 October 2023.
The gradual phasing in of CBAM over time will allow for a careful, predictable and proportionate transition for EU and non-EU businesses, as well as for public authorities. During this period, importers of goods in the scope of the new rules will only have to report greenhouse gas emissions (GHG) embedded in their imports (direct and indirect emissions), without making any financial payments or adjustments. The agreement foresees that indirect emissions will be covered in the scope after the transitional period for some sectors (cement and fertilisers), on the basis of a methodology to be defined in the meantime. The objective of this transition period is to serve as a pilot and learning period for all stakeholders (importers, producers and authorities) and to collect useful information on embedded emissions to refine the methodology for the definitive period.
Once the permanent system enters into force on 1 January 2026, importers will need to declare each year the quantity of goods imported into the EU in the preceding year and their embedded GHG. They will then surrender the corresponding number of CBAM certificates. The price of the certificates will be calculated depending on the weekly average auction price of EU ETS allowances expressed in €/tonne of CO2 emitted. The phasing-out of free allocation under the EU ETS will take place in parallel with the phasing-in of CBAM in the period 2026-2034.
A review of the CBAM’s functioning during its transitional phase will be concluded before the entry into force of the definitive system. At the same time, the product scope will be reviewed to assess the feasibility of including other goods produced in sectors covered by the EU ETS in the scope of the CBAM mechanism, such as certain downstream products and those identified as suitable candidates during negotiations. The report will include a timetable setting out their inclusion by 2030.
Next steps
The European Parliament and the Council will now have to formally adopt the new Regulation. Once formally adopted by the co-legislators, the final set of rules and methodology for applying the CBAM will be further specified in an implementing act to be adopted by Commission after consulting the CBAM Committee, made up of experts from EU Member States. The CBAM will then enter into force on 1 October 2023 in its transitional phase.
Compliments of the European Commission.
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I want to debrief you on a comprehensive day of high-level discussions we had today here in Beijing. I met with President Xi, both in a joint meeting with President Emmanuel Macron and then in a bilateral meeting. I also had a meeting with Prime Minister Li.
Let me start with EU-China relations. It is an extensive and complex relationship that we have. For both of us, this relationship has a significant impact on our prosperity and our security. For China, because the European Union is the first export destination, while China is in the European Union the third export destination. If I give you one concrete figure, this means trade of more than EUR 2.3 billion per day in 2022. At the same time, our trade relationship is increasingly imbalanced. Over the last ten years, the European Union’s trade deficit has more than tripled. It reached almost EUR 400 billion last year. And we discussed that, because this trajectory is not sustainable and the underlying structural issues need to be addressed. I conveyed that European Union businesses in China are concerned by unfair practices in some sectors – unfair practices that impede their access to the Chinese market. For example, if you take the EU agri-food products, they face significant hurdles. Or if you take medical devices as an example, they are being excluded from the market by discriminatory ‘Buy China’ policies. All of these sectors I am speaking about are recognised areas of European excellence. So these sectoral issues are exacerbated by ever-growing requirements imposed by China that apply across the board: be it, for example, increasing pressures to submit to technology transfer; or be it excessive data requirements; or be it insufficient enforcement of intellectual property rights. All this puts European Union companies exporting to China, and also those producing in China, at a significant disadvantage, we discussed that. And we also discussed the fact that this contrasts with the level playing field that all companies operating in the European Single Market benefit from. So against this backdrop, the European Union is becoming more and more vigilant about protecting our interests and ensuring a level playing field.
In addition to these imbalances in our relationship, as you know, the European Union is growing more vigilant about dependencies. Some of these dependencies raise significant risks for us, as does the export of sensitive emerging technologies. Within this context, we all know that this leads to calls by some to decouple from China. I doubt that this is a viable or desirable strategy. I believe that we have to engage in de-risking. This means focusing on specific risks, while appreciating that there is of course a large majority of goods and services, so trade that is un-risky. Of course, different risks require different means to address them: We address the risk of dependencies through the diversification of our trade and investment relations. The risk of leakage of sensitive technologies that could be used for military purposes needs to be addressed through export controls or investment screening. But whatever the instrument we choose is, we wish to resolve the current issues through dialogue. So it is basically de-risking through diplomacy. This is why I called for – and we agreed in – the resumption of the High-Level Economic and Trade Dialogue. I am very glad that we agreed on this. Not only the High-Level Economic and Trade Dialogue, but along with this one also the High-Level Digital Dialogue. These two Dialogues should convene as soon as possible to make progress on all the different files and produce tangible results.
Let me now turn to the geopolitical environment. This visit is taking place in a challenging and increasing volatile context, in particular because of Russia’s war of aggression against Ukraine. China’s position on this is crucial for the Europe Union. As a member of the UN Security Council, there is a big responsibility, and we expect that China will play its role and promote a just peace, one that respects Ukraine’s sovereignty and territorial integrity, one of the cornerstones of the UN Charter. I did emphasise in our talks today that I stand firmly behind President Zelenskyy’s peace plan. I also welcomed some of the principles that have been put forward by China. This is notably the case on the issue of nuclear safety and risk reduction, and China’s statement on the unacceptability of nuclear threats or the use of nuclear weapons. We also count on China not to provide any military equipment, directly or indirectly, to Russia. Because we all know, arming the aggressor would be against international law. And it would significantly harm our relationship.
We also addressed human rights. I expressed our deep concerns about the deterioration of the human rights situation in China. The situation in Xinjiang is particularly concerning. It is important that we continue to discuss these issues. And I therefore welcome that we have already resumed the EU-China Human Rights Dialogue.
Besides Russia’s invasion of Ukraine, there are some areas of convergence and cooperation on specific global issues. In view of the size of our economies, we have a shared responsibility in resolving global issues, for example, first and foremost, to protect the climate and to protect our environment. I particularly welcome the positive role that China has played in delivering the Montreal-Kunming agreement on biodiversity. China has also been a driving force to reach a deal on the High Seas Treaty – this is particularly positive. On the fight against climate change, we want to see China make concrete and ambitious commitments in the run-up to COP28 in Dubai. We discussed this topic too. And I invited China to jointly prepare this COP28, in the context of our joint initiative with Canada. And of course, I would very much welcome if China would be choosing to join the Global Methane Pledge. We need China as an important player. These were the different topics in general that we have discussed and I am now looking forward to answer your questions.
Compliments of the European Commission.
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Rising tensions could trigger cross-border capital outflows and increased uncertainty that would threaten macro-financial stability
Concerns about global economic and financial fragmentation have intensified in recent years amid rising geopolitical tensions, strained ties between the United States and China, and Russia’s invasion of Ukraine.
Financial fragmentation has important implications for global financial stability by affecting cross-border investment, international payment systems, and asset prices. This in turn fuels instability by increasing banks’ funding costs, lowering their profitability, and reducing their lending to the private sector.
Effects on cross-border investment
Geopolitical tensions, measured by the divergence in countries’ voting behavior in the United Nations General Assembly, can play a big role in cross-border portfolio and bank allocation, as we write in an analytical chapter of the latest Global Financial Stability Report .
An increase in tensions between an investing and a recipient country, such as between the United States and China since 2016, reduces overall bilateral cross-border allocation of portfolio investment and bank claims by about 15 percent.
Investment funds are particularly sensitive to geopolitical tensions and tend to reduce cross-border allocations notably to countries with a diverging foreign policy outlook.
Financial stability risks
Geopolitical tensions threaten financial stability through a financial channel. Imposition of financial restrictions, increased uncertainty, and cross-border credit and investment outflows triggered by an escalation of tensions could increase banks’ debt rollover risks and funding costs. It could also drive-up interest rates on government bonds, reducing the values of banks’ assets and adding to their funding costs.
At the same time, geopolitical tensions are transmitted to banks through the real economy. The effect of disruptions to supply chains and commodity markets on domestic growth and inflation could exacerbate banks’ market and credit losses, further reducing their profitability and capitalization. The stress is likely to diminish the risk-taking capacity of banks, prompting them to cut lending, further weighing on economic growth.
The financial and real-economy channels are likely to feed off one another, with the overall effect being disproportionately larger for banks in emerging markets and developing economies, and for those with lower capitalization ratios.

In the longer run, greater financial fragmentation stemming from geopolitical tensions could also roil capital flows and key economic and financial market indicators by limiting the possibilities for international risk diversification, such as by reducing the number of countries in which domestic residents can invest.
How to curb risks
Supervisors, regulators, and financial institutions should be aware of the risks to financial stability stemming from a potential rise in geopolitical tensions and commit to identify, quantify, manage, and mitigate these threats. A better understanding and monitoring of the interactions between geopolitical risks and more traditional ones related to credit, interest rate, market, liquidity, and operations could help prevent a potentially destabilizing fallout from geopolitical events.
To develop actionable guidelines for supervisors, policymakers should adopt a systematic approach that employs stress testing and scenario analysis to assess and quantify transmission channels of geopolitical shocks to financial institutions.
Other steps include:
In response to rising geopolitical risks, economies reliant on external financing should ensure an adequate level of international reserves, as well as capital and liquidity buffers at financial institutions.

Policymakers should strengthen crisis preparedness and management frameworks to deal with potential financial instability arising from heightened geopolitical tensions. Cooperative arrangements between different national authorities should continue to help ensure effective management and containment of international financial crises, including through development of effective resolution mechanisms for financial institutions that operate in multiple jurisdictions.
The global financial safety net—a set of institutions and mechanisms that insure against crises and financing to mitigate their impact—must be reinforced through mutual assistance agreements between countries. These would include regional safety nets, currency swaps, or fiscal mechanisms—and precautionary credit lines from international financial institutions.
In the face of geopolitical risks, efforts by international regulatory and standard-setting bodies, such as the Financial Stability Board and the Basel Committee on Banking Supervision, should continue to promote common financial regulations and standards to prevent an increase in financial fragmentation.

Ultimately, policymakers should be aware that imposing financial restrictions for national security reasons could have unintended consequences for global macro-financial stability. Given the significant risks to global macro-financial stability, multilateral efforts should be strengthened to reduce geopolitical tensions and economic and financial fragmentation.
Authors:

MARIO CATALÁN
Fabio Natalucci
Mahvash S. Qureshi
Tomohiro Tsuruga

—This blog is based on Chapter 3 of the April 2023 Global Financial Stability Report,“Geopolitics and Financial Fragmentation: Implications for Macro-Financial Stability.”
The post IMF | Geopolitics and Fragmentation Emerge as Serious Financial Stability Threats first appeared on European American Chamber of Commerce New York [EACCNY] | Your Partner for Transatlantic Business Resources.

Interview with Fabio Panetta, Member of the Executive Board of the ECB, published as an article by Eshe Nelson entitled “Are Big Profits Keeping Prices High? Some Central Bankers Are Concerned.” in The New York Times, 31 March 2023 |
After months of fretting about whether workers’ rising pay would keep inflation uncomfortably high, central bankers in Europe have another concern: large company profits.
Companies that push up their prices above and beyond what is necessary to absorb higher costs could be fueling inflation that central bankers need to combat with higher interest rates, a policymaker at the European Central Bank warned, suggesting that governments might need to intervene in some situations.
Policymakers, long preoccupied with higher pay’s tendency to prompt companies to raise their prices, generating a wage-price spiral, should also be alert to the risks of a so-called profit-price spiral, said Fabio Panetta, an executive board member at the E.C.B. At a conference in Frankfurt last week, he pointed out that in the fourth quarter of last year half of domestic price pressures in the eurozone came from profits, while the other half stemmed from wages.
His concerns have been echoed in recent remarks by the E.C.B.’s president, Christine Lagarde, and the Bank of England governor, Andrew Bailey. Although inflation in Europe has begun to ease from last year’s double-digit peaks, the rates remain far above 2 percent, the target of most central banks.
“There’s a lot of discussion on wage growth,” Mr. Panetta said in an interview this week. “But we are probably paying insufficient attention to the other component of income — that is, profits.”
Profit margins at public companies in the eurozone — measured by net income as a percentage of revenue — averaged 8.5 percent in the year through March, according to Refinitiv, a step down from a recent peak of 8.7 percent in mid-February. Before the pandemic, at the end of 2019, the average margin was 7.2 percent.
There has been a similar phenomenon in the United States, where companies reported wide profit margins last year despite the highest inflation in four decades.
Companies could be increasing prices because of higher input costs (the expenses of producing their goods or services), or because they expect future cost increases, or because they have market power that allows them to raise prices without suffering a loss of demand, Mr. Panetta said. Some producers could be exploiting supply bottlenecks or taking advantage of this period of high inflation, which makes it more challenging for customers to be sure of the cause of price increases.
“Given the situation which prevails in the economy, there could be ideal conditions for firms to increase their prices and profits,” he added.
“I’m not here to pass a judgment on how fair or unfair” price-setting is, Mr. Panetta insisted, but rather to explore all of the causes of inflation. He is a member of the E.C.B.’s six-person executive board that sets policy alongside the governors of the 20 central banks in the eurozone.
There are sectors where “input costs are falling while retail prices are increasing and profits are also increasing,” Mr. Panetta said. “So this is enough to be worried as a central banker that there could be an increase in inflation due to increasing profits.”
The average rate of inflation for the 20 countries that use the euro has been falling for five months — to 6.9 percent over the year through March — but core inflation, which excludes volatile energy and food prices, a measure used by policymakers to assess how deeply inflation is embedding in the economy, has continued to rise.
Central bankers tend to focus on the risk that jumps in pay will lead to persistently high inflation, especially in Europe where wages tend to change more slowly than in the United States. The E.C.B. is even developing new tools to measure changes in wages more quickly.
But this intense focus on wages has provoked some criticism. Mr. Bailey of the Bank of England was called out last year for suggesting workers should show restraint in asking for higher wages.
As inflation persists, attention has turned to corporate profits. There is uncertainty about what will happen as prices for energy and other commodities keep falling: Will companies restrain themselves from raising prices further?
Last week, Ms. Lagarde raised the issue of profits, saying there needed to be fair burden sharing between companies and workers to absorb the hit to the economy and income from higher energy prices.
In Britain, Mr. Bailey told companies to bear in mind when setting prices that inflation was expected to fall. Across the Atlantic, last year Lael Brainard, who was then the vice-chair of the U.S. Federal Reserve, suggested that amid high profit margins in some industries, a reduction in markups could bring down inflation.
In Europe, companies were able to protect their profit margins last year from high inflation more than expected, Marcus Morris-Eyton, a European equities analyst at Allianz Global Investor, said.
“Corporates had more pricing power, at an average level, than most investors expected,” he said.
This year, he expects there will be more variety in profit margins. “The average European company will face far greater margin pressure this year than they did last year,” Mr. Morris-Eyton said. That’s because of higher wage costs but “partly because as input costs have fallen, there is greater pressure from your customers to lower prices.”
Last year, record-breaking profits by energy producers angered consumers who faced high energy bills, while governments spent billions to protect households from some of those costs. But as energy prices have fallen, consumers are still experiencing rising food prices. In the eurozone, the annual rate of food inflation rose to 15.4 percent in March.
“To a certain extent there’s been also an opportunistic move by some big manufacturers to actually increase their prices, sometimes above their own cost increases,” said Christel Delberghe, the director general of EuroCommerce, a Brussels-based organization representing wholesale and retail companies. “It’s kind of a free-riding on a high price environment.”
It’s a factor squeezing retail profits, alongside the rising costs of products they buy and resell and higher cost of operations.
There is a notable disparity in profit margins between food producers and retailers, a traditionally low-margin business. Unilever and Nestlé each reported profit margins in the high teens for 2022, while the French supermarket company Carrefour reported a margin of about 3 percent. Unilever raised prices for its products more than 11 percent last year and Nestlé more than 8 percent, but in both cases the companies said they had not passed on all the effects of higher costs to consumers.
Ms. Delberghe said she feared the blame for higher prices was unfairly going to land on retailers. “We’re extremely worried because indeed there is this perception that prices are going up and that it’s very unfair,” she said. Retail businesses are getting a lot of pushback, including from governments trying to take action to stop price increases in stores.
Mr. Panetta said governments should step in where necessary, in part because their fiscal support programs have helped keep profits high. “If there is a sector in particular where market power is abused or there is insufficient competition, then there should be competition policies that should intervene,” he said.
But it was also a message to companies.
“It should be clear to producers that strategies based on high prices that increase profits and inflation may turn out to be costly for them,” he said.
The cost? Higher interest rates.
Compliments of the European Central Bank.
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The Council and the Parliament negotiators today reached a provisional political agreement to raise the share of renewable energy in the EU’s overall energy consumption to 42.5% by 2030 with an additional 2.5% indicative top up that would allow to reach 45%. Each member state will contribute to this common target. This provisional political agreement will now need to be endorsed by both institutions.
The Council and Parliament negotiators provisionally agreed on more ambitious sector-specific targets in transport, industry, buildings and district heating and cooling. The purpose of the sub-targets is to speed-up the integration of renewables in sectors where incorporation has been slower.
Transport
The provisional agreement gives the possibility for member states to choose between:

a binding target of 14.5% reduction of greenhouse gas intensity in transport from the use of renewables by 2030
or a binding share of at least 29% of renewables within the final consumption of energy in the transport sector by 2030

The provisional agreement sets a binding combined sub-target of 5.5% for advanced biofuels (generally derived from non-food-based feedstocks) and renewable fuels of non-biological origin (mostly renewable hydrogen and hydrogen-based synthetic fuels) in the share of renewable energies supplied to the transport sector. Within this target, there is a minimum requirement of 1% of renewable fuels of non-biological origin (RFNBOs) in the share of renewable energies supplied to the transport sector in 2030.
Industry
The provisional agreement provides that industry would increase their use of renewable energy annually by 1.6%. They agreed that 42% of the hydrogen used in industry should come from renewable fuels of non-biological origin (RFNBOs) by 2030 and 60% by 2035.
The agreement introduces the possibility for member states to discount the contribution of RFNBOs in industry use by 20% under two conditions:

if the member states’ national contribution to the binding overall EU target meets their expected contribution
the share of hydrogen from fossil fuels consumed in the member state is not more 23% in 2030 and 20% in 2035

Buildings, heating and cooling
The provisional agreement sets an indicative target of at least a 49% renewable energy share in buildings in 2030.
It provides for a gradual increase in renewable targets for heating and cooling, with a binding increase of 0.8% per year at national level until 2026 and 1.1% from 2026 to 2030. The minimum annual average rate applicable to all member states is complemented with additional indicative increases calculated specifically for each member state.
Bioenergy
The provisional agreement strengthens the sustainability criteria for biomass use for energy, in order to reduce the risk of unsustainable bioenergy production. It ensures the application of the cascading principle, with a focus on support schemes and with due regard to national specificities.
Faster permits for projects
The provisional agreement includes accelerated permitting procedures for renewable energy projects. The purpose is to fast-track the deployment of renewable energies in the context of the EU’s REPowerEU plan to become independent from Russian fossil fuels, after Russia’s invasion of Ukraine.
Member states will design renewables acceleration areas where renewable energy projects would undergo simplified and fast permit-granting process. Renewable energy deployment will also be presumed to be of ‘overriding public interest’, which would limit the grounds of legal objections to new installations.
Next steps
The provisional political agreement reached today will first be submitted to the EU member states’ representatives in the Committee of Permanent Representatives in the Council and then in the Parliament for approval.
The directive will then need to be formally adopted by the Parliament and then the Council, before being published in the EU’s Official Journal and enter into force.
Background
The proposal to revise the renewable energy directive, along with other proposals, tackles the energy aspects of the EU’s climate transition under the ‘Fit for 55’ package.
The Commission presented the ‘Fit for 55’ package on 14 July 2021. This package aims to align the EU’s climate and energy legislative framework with its 2050 climate neutrality objective and with its objective of reducing net greenhouse gas emissions by at least 55% by 2030 compared to 1990 levels.
In addition, as part of the REPowerEU plan, the Commission proposed on 18 May 2022 a series of additional targeted amendments to the renewable energy directive to reflect the recent changes in the energy landscape. The elements of the proposal were integrated into the agreement found today.
The current renewable energies directive is in force since December 2018. It sets an EU-level target of 32% share of renewable energy in the total EU energy consumption by 2030 at EU level.
Compliments of the European Council and the Council of the European Union.
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Today, the European Commission adopted a proposal for a Directive making it easier for companies to expand the use of digital tools and processes in EU company law. The proposal aims to facilitate cross-border companies’ operations and to increase business transparency and trust by making more information about companies publicly available at EU level. It will also cut red tape for cross-border businesses, saving around €‎437 million of administrative burden per year, thanks to an EU Company Certificate or the application of the “once-only principle”. The proposal will contribute to further digitalisation of the single market and help companies, in particular, small and medium-sized ones to do business in the EU.
Cutting red tape and administrative burden
To cut red tape and alleviate the administrative burden for cross-border business, the proposed rules include:

Application of the “once-only principle” so that companies do not need to re-submit information when setting up a branch or a company in another Member State. The relevant information can be exchanged through the Business Registers Interconnection System (BRIS);

An EU Company Certificate, containing a basic set of information about companies, which will be available free of charge in all EU languages;

A multilingual standard model for a digital EU power of attorney which will authorise a person to represent the company in another Member State;

Removing formalities such as the need for an apostille or certified translations for company documents.

Improving transparency and trust in cross-border business
The proposal is updating the existing EU rules for companies (Directive (EU) 2017/1132) to adapt them further to the digital developments and new challenges, and to stimulate growth and competitiveness in the single market.
To ensure greater transparency and trust in companies the proposed rules are intended to:

Make sure that important information about companies (e.g. about partnerships and groups of companies) is publicly available in particular at EU level through the BRIS;
Make searches for information about companies in the EU easier by allowing a search through BRIS and, at the same time, through two other EU systems interconnecting national beneficial ownership registers and insolvency registers;
Ensure that company data in business registers is accurate, reliable and up-to-date, for example by providing for checks of company information before it is entered in business registers in all Member States.

Next steps
The proposal will now be discussed by the European Parliament and the Council. It is proposed that once adopted, Member States will have two years to transpose the Directive into national law.
Background
Companies are at the heart of the single market. Thanks to their business activities and investments, including on a cross-border basis, they play a leading role in contributing to the EU’s economic prosperity, competitiveness and in carrying through the EU’s twin transition to a sustainable and digital economy. To this end, companies need a predictable legal framework that is conducive to growth and adapted to face the new economic and social challenges in an increasingly digital world. The proposed measures will apply to around 16 million limited liability companies and 2 million partnerships in the EU.
The proposal provides for the second step of the digitalisation of EU company law. The 2019 Digitalisation Directive (EU) 2019/1151 ensured that company law procedures can be carried out online, and in particular that companies can be set up online. This proposal is complementary and aims to increase the availability of company information, in particular, at EU level and to remove administrative barriers when companies and authorities use such information in cross-border situations. Overall, the proposal promotes “digital by default” solutions when accessing or using company information in interactions between companies and business registers or authorities. The proposal will further rely on the use of trust services and will ensure that solutions such as the EU Company Certificate are compatible with the forthcoming European Digital Identity Wallet.
It will contribute to the digitalisation objectives set out in the Communications 2030 Digital Compass: the European way for the Digital Decade and Digitalisation of Justice in the European Union – A toolbox of opportunities, and will facilitate cross-border expansion by SMEs in line with Communications Updating the 2020 New Industrial Strategy and SME Strategy for a sustainable and digital Europe.
As announced in the 2023 Commission Work Programme this proposal is one of the key actions under the political priority of “Europe fit for the digital age”.
Compliments of the European Commission.
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Interview with Philip R. Lane, Member of the Executive Board of the ECB, conducted on 22 March by Kolja Rudzio | 29 March 2023 |
In recent weeks, banks have collapsed in the US and Switzerland. Could the same happen in the eurozone?
Let me first strongly emphasise that what we’re seeing in the euro area in terms of tensions is a spillover from the US and from Switzerland. And please remember that we had a severe banking crisis in the European Union 15 years ago. As a result of that, we now have very tight regulation and very tight supervision of the banks. So our baseline is that the European banking system has a lot of capital and banks have been prudent in their lending decisions.
“Baseline” means you think this is the most likely scenario.
Yes. Of course we’re closely monitoring developments and are on our guard, but we don’t expect to see the same situation as in the US or in Switzerland to be the most likely scenario here in the euro area.
You don’t expect it, but you can’t rule it out, can you?
The history of banking teaches us that it’s very important to maintain confidence. We don’t have any reason to believe that a major problem would emerge. However, if it did, the ECB is able to respond. We have many tools, we can provide liquidity, and we can make sure we don’t see the types of bank runs that were evident in these examples.
If banks had to be rescued in the EU, would taxpayers have to pay for it again?
Here in the European Union and in the euro area, one of the most important lessons was to make sure the banks have a lot of capital, so that they are very capable of absorbing losses. The European banking system is well capitalised and profitable. And the macroeconomic outlook is positive. These are not the circumstances in which, in the baseline, we expect to see the banking system come under significant pressure.
At a recent conference, you called the financial turmoil we just saw a “non-event”. Could you explain that?
We’ve seen significant issues in the US and in Switzerland. But in the end, only certain types of banks with very specific problems were involved. We don’t see that as a general issue in the banking system. Of course people ask questions immediately after a policy intervention such as in the US or Switzerland. But I think it remains the case that there’s no direct read-across to the euro area. In the baseline, we expect these tensions will settle down.
That means a non-event?
Yes, from a macroeconomic perspective. The next level up from a non-event is if the banks become risk-averse because of a loss of confidence. Then there would be some impact on the economy, but it would still be limited.
Are you seeing that already?
It’s too early to tell, but this is something we’ll be looking at in the coming weeks. The third scenario is if it becomes more severe. But in our jargon, it’s a “tail event”. It is at the far end of the probability distribution – very unlikely. So we’re monitoring, but it’s still too early to extrapolate that this is going to be a significant issue.
Were you surprised by the banking problems we just witnessed?
For many years, the European Central Bank and other institutions have run projects playing through what happens if interest rates go up suddenly. I, by the way, participated in one of these projects around 2015. What stress such rate rises might put on the financial system is something we’ve studied for years. The exact details of which particular bank, what particular scenario, of course, always contains an element of surprise.
But was the high pace of the rate hikes you decided upon at the ECB perhaps a surprise for people?
I don’t think it really has been something that’s so sudden or severe. Let me make a number of observations here. Number one is: behind the increase in interest rates is the fact that inflation rose quite quickly. In the context of inflation rising that quickly, it would have been a surprise if interest rates did not also go up relatively quickly. Number two: these increases were from super-low levels. It should not be surprising to anyone that rates went from -0.5 per cent to, let’s say, about 2 per cent. That essentially was normalising policy. That was always expected, even if there was the question of the timing of it. Now, because of high inflation, we needed to do more. This is why we’ve brought rates above their long-run value of about 2 per cent, now to 3 per cent, and we’ve signalled they will go higher, if needed. The third point is we started really around December 2021, so already 16 months ago. First of all, we ended the pandemic emergency purchase programme, then we ended Quantitative Easing in general in June last year, then we moved rates out of negative in July. But already from January onwards, the market understood that rate hikes were coming. So we have always gone step-by-step, in part to allow the financial system to adjust.
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.
Compliments of the European Central Bank.
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