Interview with Philelefteros

Interview with Christine Lagarde, President of the ECB, conducted by Theano Theiopoulou and published on March 27, 2022

26 March 2022

Do you think that the European response to the Russian invasion of Ukraine is strong enough?

Let me first of all express my deep sorrow at the continuing loss of so many lives as a result of Russia’s war against Ukraine. The decisions of the EU governments clearly demonstrate their determination to respond to this horrible act of aggression and their solidarity with the people of Ukraine. It is crucial that sanctions are implemented effectively and the ECB is doing its part. While we do not have a mandate to assess and enforce banks’ compliance with the different sanctions regimes, we are working with the relevant European and national authorities to ensure banks are clear on how to apply sanctions.

Although we were about to put the pandemic behind us, we are now facing a new crisis due to war. How much can it damage or delay the economic recovery that was underway worldwide and what is the risk of a recession in the euro area if the war continues?

The war is expected to have a considerable impact on the world economy, and especially the European economy due to Europe’s proximity to Russia and dependence on Russian oil and gas. It is likely to reduce euro area growth and increase inflation in the short term through higher energy and commodity prices, confidence effects and disruption to international trade. Of course, the overall impact will largely depend on how long the war lasts.

Our baseline projections, which include an early assessment of the impact of the war, do not foresee a recession, given the strong eurozone labor market and the fading pandemic. Projections call for economic growth of 3.7% this year and 2.8% in 2023. However, given the great uncertainty, the ECB staff has prepared two alternative scenarios: one adverse and one severe. In the severe scenario, growth could be as low as 2.3% in 2022. But there is a lot of uncertainty surrounding these estimates.

However, is there a risk of stagflation? Could the eurozone economy stall?

So far, incoming data does not point to a material risk of stagflation. The euro area has returned to its pre-crisis level of output, growth continues and the labor market remains strong. In the short term, the rise in inflation is due to factors related to the pandemic, fueled more recently by the war-related shocks to global energy prices.

Before the invasion of Ukraine, there were increasing calls in many member states to raise interest rates and tighten monetary policy to control inflation. Do you think that the events in Ukraine will mean a postponement of such decisions or are higher rates still possible in 2022?

As you know, our decisions and the path of policy normalization depend entirely on data. Our forward guidance is very clear about the conditions we need to see before we consider raising interest rates.

Under current conditions, more than ever, we need optionality in our monetary policy. That is clearly reflected in our latest political decisions in March. We reviewed the path for net asset purchases and will reduce them step by step in the second quarter of this year. We note that if incoming data supports the expectation that the medium-term inflation outlook will not weaken even after the end of net asset purchases, we will wrap up net asset purchases in the third quarter. If, on the other hand, the outlook changes and financing conditions deteriorate inconsistently with our two percent inflation target, we stand ready to revise our net asset purchase schedule in terms of size and/or duration.

We remain very attentive to the prevailing uncertainties. The calibration of our policies will continue to be data dependent and will reflect our evolving assessment of the outlook. We will take the necessary measures to fulfill our mandate to seek price stability and safeguard financial stability.

How real is the risk of the ECB’s worst-case scenario of 7.1% inflation in 2022 materializing?

This is not the reference scenario for the ECB experts’ projections. It is also important to note that, in all of our scenarios, inflation is expected to decline and settle at levels close to our two percent target in 2024.

Was it possible that the ECB foresaw the huge problem of soaring energy prices even before the Russian invasion of Ukraine?

Higher energy prices are mainly the result of geopolitical tensions, and it is not easy to foresee the impact of such tensions. We try to deal with the high uncertainty arising from the current situation, so our latest projections were accompanied by the most negative scenarios. Energy prices were also affected by unusual weather conditions, which were also not possible to forecast.

Is it possible to reduce the EU’s dependence on Russian gas, oil and other raw materials in the coming years?

Many European governments are working hard to reduce their dependence on Russian energy, but this takes time. Russia accounts for 22% of energy imports from the euro area. These cannot be replaced overnight. The euro zone is also heavily dependent on other Russian raw materials, such as nickel, cobalt and vanadium. Economic dependence on hostile actors is indeed a vulnerability.

Cyprus is highly dependent on Russian tourism and Russian business. How serious do you think the impact of the war will be on the Cypriot economy?

The war will affect the Cypriot economy through various channels. Arrivals from Russia and Ukraine accounted for up to 25% of the total, so the authorities’ initiatives to replace and diversify tourism sources are the right approach. In addition, given the importance of Cyprus as a hub for foreign direct investment to and from Russia, professional services such as accounting, consulting and legal services are also expected to be affected. Finally, the Cypriot economy will be affected by inflationary pressures stemming from rising energy costs due to its reliance on oil imports for power generation.

However, you know very well that every challenge can also be an opportunity. Cyprus is the easternmost and southernmost member of the EU. It offers a European institutional framework, the security of the euro as a currency and can serve as a business hub in the Middle East and North Africa region. Your country has shown time and time again that it is agile and that it can face difficulties and come out stronger.

After the crisis of 2013, the Cypriot banking system considerably reduced deposits of Russian funds and exposure to the Russian market. How do you assess the way you are handling the turmoil caused by the war? Has the impact of bank sanctions been more significant in other euro area countries?

Direct exposures of the Cypriot banking sector to the Russian economy are generally quite limited and continue to decline. Loss of profitability from card transactions or bank transfer fees related to Russian customers is also limited. Indirect effects through tourism are considerable, but can be mitigated through efforts to diversify tourism sources.

Let me also point out that significant progress has been made in recent years in stabilizing the banking system, improving solvency and liquidity positions, and reducing the stock of legacy assets. The Cypriot banking system is today better prepared to withstand the current crisis. The last time I was in your beautiful country, ten years ago, things looked extremely difficult. But Cyprus is in a totally different position today, having effectively dealt with many of the problems it had in the past.

On Thursday, RCB Bank announced that it will close its business and refund all deposits. Your comment on that?

This was a business decision and I will not comment on individual institutions as per our standard policy at the ECB. The important thing is that all deposits will be redeemed. In a sense, this decision dispels some of the uncertainty and should increase confidence in the Cypriot banking sector in the medium term.

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