“Interest rate cuts are premature at the current juncture” Interview with: Frankfurter Allgemeine Sonntagszeitung
The Interview was conducted by Gerald Braunberger and Dennis Kremer.
Translation: Deutsche Bundesbank
Mr Nagel, you enjoy playing tennis. If the fight against inflation were a game of tennis, what would be the state of play right now?
I’ve been playing tennis since childhood, and it has taught me that psychology is very important. It’s not always the one who plays the better shots that comes out on top; it’s often the one who shows dogged persistence and mental fortitude. There are some striking parallels with our fight against inflation: we mustn’t let up too soon and lose focus. I can’t say whether we are currently playing a tie-break in the fifth set. But we’ve certainly reached a stage in the game that will decide the outcome.
So is the first interest rate cut coming in the summer or not?
We look at the data, not the calendar. We of the Governing Council of the European Central Bank (ECB) are confident that our monetary policy is working and will bring inflation back to its target of 2%. Inflation has been decreasing significantly, and that’s a good sign. It also looks as though a soft landing will be possible in the euro area – in other words, reducing inflation without simultaneously putting too much of a strain on economic activity.
If everything is working as well as you claim, why are so many central bankers warning that the last mile of the inflation battle will be the most arduous?
Because the temptation to ease off too soon is so strong. Let me explain by using an example: We currently appear to be administering the correct “dose” of interest rate increases. But, just as in medicine, it is also important in the field of monetary policy to keep a close eye on the “patient”. We mustn’t jeopardise what has been achieved by reducing the dose too early. That’s a challenge. As I see it, the price outlook still isn’t clear enough: that’s why interest rate cuts are premature at the current juncture.
What worries you more: geopolitical unrest or higher wages, for example as a result of wage disputes? Both can trigger a fresh surge in inflation.
Both of these factors could indeed play a role. A geopolitical escalation undoubtedly represents a particular risk. For instance, Russia’s terrible war of aggression against Ukraine drove up energy prices from one day to the next. This put a considerable strain on enterprises and households, as well as creating uncertainty. Even though we have now overcome this shock, energy prices are still subject to major fluctuations. The Middle East is another source of uncertainty right now; the Red Sea shipping route is under threat. That is why we monetary policymakers would be well advised to make decisions based on actual data and the current outlook. The same applies to wages. These don’t tend to rise until relatively late, which makes them a lagging indicator. Profits have already increased earlier. Both profits and wages can have a strong impact on the inflation rate; that’s something we need to bear in mind.
Something else is making your job more difficult, too: although the German economy is faring badly, unemployment is hardly rising.
Indeed: in previous economic cycles, periods like the current one frequently resulted in people losing their jobs – a terrible outcome for those affected. At the same time, that eased the pressure on wages and thus on prices. This classical relationship seems to no longer apply. 2023 was not a good year for the German economy, and 2024 won’t be a year of strong growth, either. Yet enterprises are retaining their employees, because they are worried they might not find the staff once matters pick up again. The shortage of skilled workers and demographic change are causing a noticeable shift in this regard. What matters for us, though, is that we push inflation down to our target. And we will succeed in doing so, even if the labour market is robust.
As a Bundesbanker, aren’t you a little pleased about the economic downturn? After all, it’s showing that the higher interest rates are working.
Pleased is how I would have felt if Alexander Zverev had won his semi-final at the Australian Open. In all seriousness, though, of course I am not happy about a lull in activity, let alone a recession. However, my task as Bundesbank President is to pursue price stability, and I want to do a good job of that. I still have distinct memories of the scepticism directed towards central bankers when inflation rose so steeply back in 2022. Now, it looks like inflation in 2025 will be close to our target – and that’s with very low unemployment, too. To my mind, that’s a decent result, all told.
The German inflation rate fell quite significantly in January. Was that a one-off occurrence?
As expected, the inflation rate in Germany fell again in January – to an estimated 3.1% as measured by the Harmonised Index of Consumer Prices. There was an outlier to the upside in December, when inflation came in at 3.8%. But that was due to a one-off factor in energy prices that now no longer applies. Over the next few months, I expect the prices of food and other products to continue to normalise. The good news is that the inflation rate is moving broadly in the right direction in 2024: that is to say, downwards.
Financial markets are speculating about rate cuts coming sooner, in the second quarter already. Central Bankers like you endeavour to temper such expectations. Are you not paying too much attention to markets?
I wouldn’t put it that way. It’s in our interest for the general public and financial markets, too, to understand our monetary policy stance. We want to avoid a situation in which market financing conditions become too loose and are thus no longer able to sufficiently dampen inflation. Abrupt price fluctuations are also unwelcome. There is no point in watching financial markets with eagle eyes the whole time, to be sure. Now and again, though, we central bankers do need to send a signal to market participants. It doesn’t matter to me whether market participants’ bets pay off or not – our job isn’t to protect people when speculation goes wrong. But if there is a mismatch between financial conditions and the inflation outlook, it becomes more difficult to maintain price stability. And that is our job – that’s just the way it is.
So if financial markets barely respond, as was the case following the latest ECB meeting, does that mean you’re happy?
You wouldn’t be wrong. Markets appear to have done a good job of anticipating the ECB Governing Council’s most recent decisions.
In the past, the ECB Governing Council sought to provide a rough outline of future monetary policy intentions in the form of forward guidance. Has this tool been completely abolished?
No, but the tool isn’t really suited for uncertain times in which multiple scenarios are conceivable for the economy. There is considerable uncertainty as to how the situation will develop. That is why we cannot currently provide any such forward guidance on our future path. But there’s one area in which we are already staking out a clear course right now – our asset purchase programmes. We will significantly run down our bond holdings by the end of the year.
Your predecessor Jens Weidmann recently called for this process to advance even more quickly.
I understand the position, but we on the Governing Council have taken a decision on this issue, and I’m fully committed to that.
There is a prevailing feeling that many banks are using the situation to their advantage. They are receiving 4% interest on the excess reserves they hold with the ECB, but they are only rarely passing this interest rate on to savers in exceptional cases. Shouldn’t you be doing something about this?
It is true that many banks are not fully passing on the interest rate impulse on the deposits side. We want monetary policy to work as efficiently as possible. This is precisely why we decided to no longer remunerate the minimum reserves that banks hold with the ECB. I make no secret of the fact that I could have imagined a larger, unremunerated minimum reserve.
Are you receiving angry letters from bank managers? After all, you have spoken out in favour of completing the banking union – in other words, in favour of setting up a single European deposit insurance scheme. This is a notion that has been rejected by savings banks.
No, I haven’t received any angry letters. But I am in touch with the industry, and I know that there is not much enthusiasm for the idea here in Germany. Nevertheless, I believe that this discussion is an important one and initiated it on purpose. We need the banking union and capital markets union – that is exactly what Federal Chancellor Olaf Scholz recently called for in his budget speech. As I see it, the whole issue is part of a bigger picture: Europe needs to come closer together and build up greater resilience – and the same can be said of our financial sector. I am sure that there is room for compromise here in which the savings banks and people’s banks can be part of the solution.
Many savers fear that their money would no longer be safe if there were a single European deposit insurance scheme. Can you put their minds at rest?
Savers’ money is significantly safer than it used to be. Regulation is one of the factors that has led to banks being more stable. Last spring, we saw the turmoil surrounding the regional banks in the United States and the collapse of Credit Suisse, neither of which caused any serious knock-on effects on banks in the European Union. This shows how much our financial institutions have gained in strength.
Do you have a tip for savers on what would be the best thing for them to do in these times?
I can’t give any specific recommendations, but there’s one piece of advice I can offer: regardless of the financial product in question, anyone who wants to invest money has to understand the product’s fundamentals and look into the product in detail beforehand. After all, if you were going to buy a new car, you would make sure you read the relevant test reports before buying.
Mr Nagel, you yourself recently attended a rally against right-wing extremism in Frankfurt. Why was that important to you?
Like many others, I, too, wanted to take a stand as a private individual for our democracy and against right-wing extremism and xenophobia. Moreover, Germany as an industrial and investment location is reliant on attracting qualified people from all over the world and integrating workers with a migration background. This is another reason why it is important for us to speak up if we see our democracy and fundamental values at risk.
Would you like to see more clear messages like this from the leaders of this Republic?
As citizens, we are being called upon to stand up for our democracy, perhaps even more so than before. For me there is certainly reason enough to take a stand.
Have you ever caught yourself wondering if the ECB’s mistakes may have contributed to the strengthening of the political fringes?
One should always be self-critical and question oneself. This goes for monetary policy, too. But the strengthening of the right wing is a global phenomenon, and that won’t disappear again when inflation does. I am someone who looks to the future: we have to act wisely in the here and now. I am trying to emphasise the right points for the Bundesbank.
Doesn’t there also need to be better policymaking in Berlin, especially in the area of economic and financial affairs?
Policymakers can and must stake out the right framework. We are facing major challenges in the form of the energy transition and demographic change. We need to make Germany a more attractive place to do business and preserve the groundwork that drives sustainable economic growth. For example, we have to considerably speed up approval procedures, going digital and cutting red tape. These are all examples of matters that need to be addressed. Germany needs to up its game here.
Is there any hope that progress will actually be made with the current Federal Government?
I find it too simplistic to criticise the Federal Government across the board. In 2022 it demonstrated its ability to react quickly and robustly when faced with an energy crisis. I would like to encourage the government to show the same speed on other issues as well.
How irritating is it then that you have to work with just half a team on the Bundesbank’s Executive Board? Three of the six board positions are currently vacant.
Now that Claudia Buch, Joachim Wuermeling and Johannes Beermann have stepped down, half of the Executive Board is now indeed vacant. Policymakers at the federal and state levels are responsible for filling our board positions. At present, the ball is in the court of the Federal Government and the states of Hesse and North Rhine-Westphalia. I assume that they will act in a timely manner to ensure that the Executive Board is fully staffed again soon.
You have often spoken about your weekend trips to the supermarket. Has inflation led you to go without some products altogether?
Inflation is felt by everyone in the shops. Above all, it is a burden for those who already have little money to make ends meet. But I, too, am astounded by the rise in prices for some products and, on the whole, I shop more consciously.