The interview was held by Stefan Winter und Eva Quadbeck.

Translation: Deutsche Bundesbank

We’ve been waiting for interest rates to go up for a long time, but now it seems like the only rates rising are the wrong ones: loans are becoming more expensive, yet savings are bringing in a pittance. Why is that, Mr Nagel?

It is a familiar picture: there’s a certain time lag before banks pass on higher interest rates to savers. 

It feels as though banks are buffing themselves up at the customer’s expense…

Some banks are slow to pass on higher interest rates to savers. But I expect the market to sort things out. The more banks there are that pass higher interest rates on to their customers, the more this will force the hands of others. 

When will the market sort things out?

As I see it, there is nothing to stop banks as a whole getting more competitive with one another around favourable conditions for savers. Here at the Bundesbank, we have looked into whether banks are passing on the rise in interest rates to their customers to the usual extent. The result? A yes for time deposits but, when it comes to overnight and savings deposits, it is happening more slowly than it used to – so far, at least. 

So people should wait another while before making any investment decisions?

As President of the Bundesbank, I do not give any investment tips – including, incidentally, where real estate financing is concerned. House builders have long benefited from very low interest rates. And the Bundesbank pointed out at the time that a turnaround in interest rates would happen at some point. The about-face has now had to be sharper than expected. And that bears out the rule: whenever you’re making any decision to do with money, you should factor in from the very start the potential that the market might turn.

The switch to higher interest rates came late, many are saying too late.

Hindsight is always 20/20. That’s especially true when, like us monetary policymakers, you’re working with instruments that only take effect with a delay. As a rule, we don’t see the extent to which our interest rate increases are dampening inflation until we get one to one and a half years down the line. No one predicted Russia’s war against Ukraine and the surges in gas and electricity prices that came on its tail. That said, inflation was already too high before then due to the fallout from the pandemic. It was over 5% in January 2022. Back then, when I took office, I pointed to the danger that inflation could prove more stubborn than many were thinking. Monetary policy needs to be even more stubborn and keep pushing back. That’s why interest rates had to climb. 

And now? Eight policy rate hikes later, and inflation in the euro area is still at 5.5% – and over 6% in Germany, even.

It is my expectation that we will raise the key interest rates.

The Governing Council of the European Central Bank (ECB) will have its next chance to do so on 27 July.

Precisely. Virtually everyone is anticipating a 0.25 percentage point increase. 

How much further will interest rates have to rise before inflation is back at just 2% and can be said to have normalised?

On the Governing Council of the ECB we make our decisions on a data-dependent basis, for good reason. We are in agreement: interest rates will rise as high as necessary and stay at that level for as long as is needed for us to bring inflation back to our target rate of 2%. The emerging picture so far is that there will be a further marked easing of inflation as the year goes on. And that will continue into 2024. According to projections, however, inflation will only get appreciably near the 2% mark come 2025.

More and more people are arguing that a higher rate of inflation is, fundamentally speaking, simply a case of adjusting to reality. What do you think about that?

That line of thinking has no merit whatsoever, in my view. Abandoning the 2% target would be a grave mistake. It would undermine the credibility of our commitment to ensuring price stability. Inflation expectations would rise further and, with them, inflation. That wouldn’t help anyone. 

Increases in interest rates may also spell trouble for one European government or another. Is there a danger of a new euro crisis?

The ECB comes in for a lot of flak, especially in Germany, but it has done a good job. The euro area has been around for almost 25 years now – and inflation has averaged 1.9%. The euro area has weathered many a crisis in that time, too. It is stable. 

So you would say the euro is safe?

Yes, the euro is safe.

Why is the fight against inflation so incredibly laborious?

Inflation is a greedy beast. It would therefore be a mistake to let up too soon in the fight against it and to prematurely reduce interest rates again. Unlike in the United States, supply bottlenecks and energy shortages played a much greater role in Europe. But inflation won’t go away when these problems do. At some point it no longer matters where it came from because it will keep eating its way through the economy.

Inflation is being fought through higher interest rates, thus depressing demand for goods. How great is the danger that this will lead to a recession?

It is particularly consumers who are bearing the brunt of the high inflation. Many have had to economise on account of the high prices. Our efforts to safeguard price stability will ultimately also benefit the economy. Despite the higher interest rates, economic output in Germany is expected to contract only somewhat this year, according to our forecast, and it is likely to even grow further in the euro area. In any case, the labour markets in Europe are very robust.

Governments have provided massive funding for assistance packages – first during the pandemic, then because of high energy costs. From a central banker’s perspective, was that the right move?

It was necessary to help secure livelihoods and support families and firms. In this respect, the Federal Government’s decisive response here was the right move – irrespective of criticism of individual measures. At the time, action often needed to be taken in a hurry, and undoubtedly not everything was always honed down to the last detail. However, now is the time to reassess the measures. This is necessary not only in the interests of sound public finances, but also to enable us to overcome the high inflation. For it is especially broader-spread government expenditure that plays its part in causing prices to go up. That’s because it drives up demand. 

The “traffic light” coalition (SPD, FDP, Greens) is locked in a heated debate over finances. What is your take on the current draft budget?

My concerns are not about the current budget, but about the huge off-budget special funds, which are not very transparent and are running large deficits. One piece of good news concerning the gas price assistance is, for instance, that we may not even need that much money. Which means that money will still be left over. These leftover funds, however, should then not be spent elsewhere.

Many employees have now seen significant wage increases. Is this now the feared wage-price spiral?

It was clear that, given these inflation rates, the trade unions were going to do what they are there for: to represent employees’ interests. And, in these times, what that means is, in particular, compensation for the losses in purchasing power suffered since 2022. Despite the recent significant wage increases, many have not even managed to obtain this compensation, on balance. In principle, it is extremely important to keep inflation expectations anchored. If people expect further high price increases, they are naturally going to want larger wage hikes. A price-wage spiral might well be the result. By the way, it is not just wages we are talking about here: many firms’ profits had already gone up sharply earlier.

Firms are tacking more onto prices than necessary because nobody will notice it anyway right now?

The manufacturing costs of many products have risen sharply in the past few years due to, amongst other things, more expensive raw materials. Firms passed these costs on to their customers by raising prices. What's striking, though, is that profit margins have risen as well, in some cases considerably. This means that firms, given the often very buoyant demand, have tacked on even more margin to the higher costs, which additionally fuelled price increases. Diminishing supply bottlenecks, higher interest rates and competition are likely to push profit margins back down to a degree. 

Is that an idiosyncratic phenomenon – think oil conglomerates – or do you see something to the effect of “profit inflation” across the board?

Developments in margins have differed considerably across economic sectors. The corporate sector and trade unions need to realise that we are in the process of tightening the monetary policy reins. If profits and wages should continue to rise sharply, we would have to raise interest rates even more strongly. We on the Governing Council of the ECB will do whatever is necessary to bring inflation back down to 2%.

That could have a few side effects, not just for the economy. Could, for instance, the real estate market become unstable?

We are currently witnessing a correction in the real estate market, which, however, I do not see as dangerous at present. Such a correction was to be expected. The Bundesbank has repeatedly flagged overvaluations in the real estate market. 

In the United States, the increase in interest rates caused distress at four regional banks; in Switzerland Credit Suisse was affected. Do you see any dangers to the financial system, like in 2008?

Those cases mainly came about due to flaws in the business policies of precisely those banks. Another factor was that medium-sized US banks like Silicon Valley Bank don’t have to comply with regulatory requirements under the global rules for banks. Medium-sized banks in Europe do, however.

So Europe doesn’t need to tighten up its regulation?

We can’t afford to rest on our laurels – instead, we need to look very closely and tighten up our supervision wherever “blind spots” come to light. What happened with Silicon Valley Bank showed us that we need to be quicker. In this case, social media posts helped increase the pace of a bank run. The question is whether “fake news” could also trigger something similar. I recently heard with interest from my counterpart in South Korea that banking supervisors there have a task force that systematically monitors social media. That means it sees that kind of situation evolving at an early stage. This is something we could think about in Europe, too.

The financial system is turning digital in other respects, too. And yet the Bundesbank is asking people for their views on the proposed themes for new banknotes. Do we still need paper money?

Of course. Banknotes still rank as the most important means of payment. We will continue to provide them – with the latest security features.

So what are we going to see on them?

Speaking entirely personally, I would prefer to see portraits of prominent European figures. The decision will be down to the Governing Council of the ECB. At the moment, we are weighing up various proposals. People have until the end of August to take part in a survey about potential themes for the new euro banknotes on the ECB’s website. The Governing Council of the ECB will take the results of this survey into account.

At the same time, a digital euro is under development. What do we need that for?

The world is turning increasingly digital – from certificates to train tickets, there is now a digital solution for almost everything. Wouldn’t it be altogether odd these days if central banks didn’t offer money in digital form, too? The digital euro will make digital payments faster and safer. And what’s really important, the infrastructure for this will be in Europe’s hands.

When?

The Governing Council of the ECB first has to decide whether to introduce the digital euro. But I expect we will be able to use the digital euro to shop online and make person-to-person payments in four to five years’ time.

Are you aware that many people are sceptical about this project? Some people are afraid of being monitored and dictated to by an all-powerful central bank.

Private digital payment service providers that make commercial use of their customers’ data have been around quite some time. Central banks have no commercial interest. And that’s just one of the differences. 

Is it fair to say this is a slightly touchy subject for you?

I have seen how quickly we get defensive when it comes to the digital euro. Needlessly so. Digital money is part of a digital world. If we weren’t working on it, many people would be asking us, “What about a digital euro?”. To repeat what I said earlier – cash is here to stay. The digital euro would be a useful complement to it. It’s about offering the general public more choice.

Private digital currencies such as bitcoin already exist. To stick with this term, do central banks need to defend their core product against these competitors?

No. We do not refer to bitcoin and the like as currencies. They are more like speculative objects. That’s precisely why central banks and other supervisory authorities need to keep a close eye on crypto-assets. We need to regulate and keep the risks that the crypto sector might pose to the financial system in check.

Debate about regulating this sector is especially intense in the United States right now. Are supervisors there right to take a hard line?

I think we need to regulate crypto-assets in a consistent manner. We have already made some headway in Europe. The European Union has just recently adopted a regulation governing crypto markets. But this isn’t enough because it doesn’t cover all parts of the sector. I support the broader regulatory recommendations that have just been addressed at the G20 summit in India. For regulation to take proper effect, it must be implemented worldwide.

So far, the crypto landscape has been extremely fragmented. Is there any crypto-asset at all that could potentially destabilise the financial system?

There are indeed now thousands of crypto-assets, many of which are insignificant. Even the major crypto-assets have barely any links with the financial system. I don’t see any immediate danger at the moment. That said, it would be difficult to correct any undesirable developments in this area after the event. We must be careful to avoid this.

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