Interview with Market News International

Interview with Frank Elderson, Member of the Executive Board of the ECB and Vice-Chair of the Supervisory Board of the ECB, conducted by Luke Heighton on 22 September 2023

27 September 2023

Your speech at Terschelling was something of a departure for a central banker, in that it was clearly very personal, while at the same time seeking to counter a certain pessimism regarding attempts to mitigate the effects of climate change. Are you concerned that there isn’t sufficient buy-in at the moment from, as you put it, “those who pollute, those who finance the polluters, and those who supervise the financiers of the polluters”?

Looking back at the past five years, there are many things that clearly show we are not transitioning to a zero-emission economy fast enough, with all the problems that brings economically. On the other hand, many other things are going in the right direction. My main message was that we can do this, but we need to be fast. The later the transition, the higher the cost, as our recent economy-wide climate stress test has shown. So I might have used a little more pathos than I would have done if speaking here in Frankfurt, but the message is just as clear.

Is the ECB doing enough?

As supervisors we have a multi-year strategy. We published our expectations for climate-related and environmental risks in 2020. In 2021 we asked the banks to conduct self-assessments of where they stood vis-à-vis these expectations. On the basis of what we saw a year ago, the glass is slowly filling up, but it is not yet half full and it needs to be full by the end of 2024. I do see progress – banks are now better equipped to manage climate-related and environmental risks than when we made our initial assessments. Each of our expectations has been met at least once by a bank we supervise. The glass is filling up – but it is not yet full.

Building on what the banks themselves found reasonable, we set a series of interim deadlines: the first at the end of March this year, the second at the end of 2023 and the last – by which banks need to satisfy all our expectations – at the end of 2024. And we have said that we will use all our instruments to enforce these deadlines if needed.

Banks understand that we mean what we say and that this is within our mandate, because climate-related and environmental risks translate into financial risks which must be managed by the banks. This is also acknowledged worldwide. Although you do still see differences in how fast and how ambitious supervisors are, the fact of these risks being within their mandate is no longer controversial. That is a real step forward, and one which also reflects the work of the Basel Committee on Banking Supervision, for example.

But in that speech and others you’ve highlighted the urgency that’s required. Is that compatible with what is arguably still a very gradualist approach aimed, essentially, at trying to bring banks along with you, rather than you saying “you absolutely have to do this now, and if you don’t there will be consequences”?

First of all, ask the bankers. I don’t think that they would say that this is extremely gradual – many banks probably feel that we are pursuing this rather enthusiastically. There are clear deadlines − also interim deadlines − and we will enforce them if necessary. To be very clear, that includes periodic penalty payments. That’s not a step we take lightly, so I think that this shows how serious we are when we issue supervisory expectations. Do I particularly like that? Well, I believe it’s better to convince the banks. I know we’re asking a lot, and some banks would say it’s very difficult and claim that they can’t really do anything because they lack the data. But it is also true that the risks don’t become smaller just because they are difficult to measure. There is still a lot you can do short of perfection.

But the risks are out there, and they will not wait until 2030 or 2050 to materialise – so we need to make real progress. Patchy data are better than no data at all. The same is true of the emerging art of climate modelling. Patchy climate models are better than nothing, but if you don’t even identify the gaps, you cannot really make progress towards filling them. There are many other things banks can do besides climate modelling, and we have also published a guide of best practices for banks that sets out these numerous options.

So looking at it from other directions, is there anything more that the ECB could, or should, be doing beyond compliance, such as making green investment more attractive? Might we one day see the green TLTROs (targeted longer-term refinancing operations) that commentators were discussing not so long ago?

Whereas up to now we’ve been speaking about what we are doing in our banking supervision, you are now asking a question about what we might consider in our monetary policy. Talking about possible future instruments is of course highly speculative, because whenever we design an instrument, we take into consideration all the circumstances of that particular moment. Any instrument needs to be effective to pursue our primary mandate of price stability, and it needs to be proportionate. It also depends on the environment – whether we are in a period of policy tightening or accommodation. But climate considerations are clearly part of the monetary policy strategy we adopted in 2021. I think it’s fair to assume that we will take climate considerations into account in the features of any type of instrument we may design in future − including any purchase programme.

In your speech you also mentioned the extent to which national governments subsidise fossil fuel industries. Obviously, there are limits to the ECB’s mandate, and maybe this is pushing those limits. But insofar as this issue constitutes a financial stability risk, can the ECB play a greater role? Or should it be left to private citizens to pursue the issue through the courts?

You’re talking to a lawyer, and the overriding requirement through all of this is that we act within our mandate. And when I talk to banks, I point out that we are seeing exponential growth in climate-related litigation. From our perspective, banks need to manage that risk at a time when there are certain cases in which the courts have endorsed rather far-reaching legal theories, including against states. It can no longer be taken for granted that those judgments will not be repeated or set a precedent, and that is something banks should be acutely aware of.

You said recently that there will be a just transition or no transition. Could you unpack that a little?

What I wanted to say there is that, if you look at what is happening in the world, it is clear that there is a risk of a growing antagonism – that the energy transition and climate crisis become politicised. All EU Member States have committed to becoming Paris Agreement-aligned. Not delivering on that, or postponing the transition, will lead to an economically suboptimal situation where the transition ends up being more costly. Our own analysis has also shown this time and again. Bringing attention to this issue is within our mandate.

If we could turn to monetary policy – In your last Governing Council meeting, the ECB raised interest rates again. For the final time in the cycle?

We have said it very clearly: we consider that, with the decisions we’ve made and on the basis of our current assessment, the current interest rate levels will make a substantial contribution to us reaching our inflation target in the medium term. Does that mean policy rates have peaked? Not necessarily. There is still a lot of uncertainty. That’s why we take these decisions meeting by meeting, on a data-dependent basis. Making any predictions about what we will do next would not be consistent with that approach.

How do you see the balance of risks to the inflation outlook? Is it simply that the latest hike puts the ECB on a sounder footing by guarding against any additional upward price pressures?

I think that’s exactly what it is. Of course, there are upward risks to inflation. There could, for example, be upward pressures on food and energy prices – since July we have been alluding in our monetary policy statement to the importance of weather and climate conditions in this respect. Climate change could also lead to a shift in longer-term inflation dynamics, but we need much more granular analysis into how exactly physical and transition risks will ultimately affect inflation. Helpful distinctions have also been proposed by my colleague on the ECB’s Executive Board Isabel Schnabel, analysing the impact of climate change itself, the ongoing dependency on fossil fuels and the green transition. Some aspects are certainly inflationary – 2022’s summer heatwave increased food inflation by 0.67% compared with the year before, for example, so that’s rather significant. But it could also be the case that, over much longer horizons and depending on how the transition goes, energy will become much more abundant and cheaper.

Do you see any evidence that the current interest rate environment is having a negative effect on green investment?

Any interest rate decision has an effect on investment, both green and non-green. In the end, I think the best we can do is make sure that we deliver on our price stability mandate. That will create the stable environment in which the transition – including the required investment, which needs to be sped up – can take place.

How concerned are you about the growth outlook for the euro area? Or does the primary mandate of price stability ultimately matter more?

What we’re seeing is a more protracted period of sluggish growth than we were expecting. Of course, we need to look at the various explanatory factors, such as lower demand for euro area exports, the impact of tighter financing conditions, lower residential and business investment, and the weakening services sector. On the other hand, labour markets are still strong and disposable income is expected to rise, which would have a stabilising effect on overall GDP growth. It’s also true that our primary mandate is to deliver price stability, and I think we have proven we are very determined to do that, as seen in the ten rate hikes that we’ve decided on since July 2022.

So would you consider cutting rates if growth were to surprise significantly to the downside in the coming months?

I think I’ve explained very clearly how we take our decisions. We take decisions on a meeting-by-meeting basis and we look at all the incoming data. We are comfortable with the decisions that we have taken on the basis of our recent assessments, and we will weigh any incoming data carefully, as always, in relation to our inflation outlook.

Would you need to see inflation clearly and consistently trending below 2% over the course of your medium-term projections before considering a cut appropriate? Equally, would reinvestments need to have stopped by that time?

Let me stick to what I have just said. As you know, we stand ready to adjust all our instruments as needed. Based on today’s assessments, we are comfortable that a substantial contribution is being made to the timely return of inflation to our target. We will keep rates at sufficiently restrictive levels for as long as necessary.