The interview was held by Gerald Braunberger und Christian Siedenbiedel.
Translation: Deutsche Bundesbank

Mr Nagel, the ECB raised its key interest rates by just 0.25% this time, instead of by 0.5%. Can you already be satisfied with how inflation has been tackled? 

The fight against high inflation hasn’t been won yet. I could also have imagined an interest rate step of half a percentage point. But we have already announced further interest rate moves. And we also took a decision that has long been of particular importance to me: as of July, the central bank balance sheet will be run down at a faster pace than hitherto. All in all, then, the decision was fine from my perspective.

But surely you haven’t finished fighting inflation yet?

 Most certainly not. The inflation rate may have declined over the past months, but it continues to be far too high. And as for core inflation – that is, headline inflation excluding highly volatile energy and food prices – we are actually seeing barely any movement at all. That’s not a situation we can be satisfied with.  

So why hasn’t the ECB carried on taking larger interest rate steps of 0.5 percentage points?

What matters is that we are not pausing. People are beginning to feel monetary policy dampen economic activity. And that’s precisely what it needs to do if it is to break inflation. But the size of our steps is no longer as crucial now as it was last year, when monetary policy as a whole was still loose. 

Interest rates in the euro area really have risen very quickly. Many critics thought the ECB didn’t have it in them. Some thought that you wouldn’t even manage to raise rates once ...

That’s an aspect that has often been somewhat overlooked in the commentaries. We started off in July last year and have now managed seven key interest rate hikes – by 375 basis points in all. The ECB Governing Council has never before been this vigorous in hiking its key interest rates. But inflation is also extremely high, remember. And we haven’t finished yet: interest rates should rise further still. 

Is it right to say that fears that spreads on certain euro area countries’ government bonds might get out of control as a result have proven unfounded?

It is crucial that Member States offer a prospect of sound public finances. That will provide for lower yields and spreads on government bonds. If yields were to get out of control in an unwarranted fashion and pose a serious threat to the transmission of our monetary policy, we would also be able to intervene using the Transmission Protection Instrument (TPI) we adopted last July.

So the best instrument is one that you never have to use? As in the announcement by the then ECB President Mario Draghi that he would do “whatever it takes” to rescue the euro? 

It would appear that markets have certainly taken on board our determination to act as and when necessary subject to the terms of the TPI.

In a situation like the current one, would it be possible, in principle, to derive an optimal interest rate path from economic models?

Of course there are models that can be put into the service of determining the optimal monetary policy. We calculate such interest rate paths at the Bundesbank. And financial markets, too, have their own expectations for interest rates, including for the “terminal rate” – that is, the interest rate level at which we might end our hiking cycle. Following the latest ECB decision, these market expectations are now ten basis points lower than they used to be. But let me make one thing perfectly clear: markets aren’t always right. In recent months they have been too optimistic, if anything, as far as inflation is concerned. 

Markets take sides ...

I take sides, too – I’m on the side of price stability. And the current level of interest rates still isn’t enough to ensure stable prices. 

Did concerns about the banking tremors also play into the ECB’s decision to only risk a smaller interest rate step this time?

Needless to say, we cannot turn a blind eye to these events in our monetary policy deliberations. I do believe, however, that this is not a systemic crisis. These are specific risks, notably at regional banks in the United States. Supervisors there will be looking closely at the situation and will rectify matters as necessary. In other words, I haven’t revised my inflation assessment significantly downwards as a result of those developments. And that’s what matters here.

Were you worried about banks in Germany?

Of course we look for any potential channels of contagion to the European and especially the German financial system and consider whether there are similar risks at our banks. The interest rate reversal and economic uncertainty are creating interest rate risk and credit risk here as well. But our supervisors have always given careful consideration to these risks. And if you look at the latest balance sheet data, the banks are faring well. I see no reason to worry. Even so, we need to remain vigilant in the regulation and supervision of our banks and address blind spots. 

What’s your take on the solution that Switzerland came up with? After all, the bank in question, Credit Suisse, is no stranger to the German banking system ... 

I myself have already been through one financial crisis or another in my time, and I’ve got a rough idea of what came crashing in on my Swiss colleagues within a short space of time. It’s hardly surprising that a decision like that will invariably stoke political controversy. However, given the necessity and the urgency of the situation on that one crucial weekend, the solution ultimately had a stabilising effect. 

Is now the time to learn more lessons from the banking tremors?

It would certainly be a mistake not to use this moment as an opportunity for renewed reflection. For example, we need to look very closely at whether our framework for bank resolutions is the right fit to deal with comparable risks. That’s what we are currently doing in the EU. I think we’re well equipped, generally speaking, but we may have to make the odd tweak here and there.

Whereabouts, for example?

The transparency of trading in credit default insurance should be reconsidered, for example. Moreover, the banking tremors have shown that digital banking and social networks can turbocharge bank runs. 

Given that information like that spreads at an ever-faster pace, it’s easy to get into a situation where the central bank is the only institution that can really respond. You can just say, €100 billion for Credit Suisse – and no-one else can …

That is precisely what we are seeking to avoid. It would be wrong for central banks to become the firefighters for credit institutions. 

Are there any plans to take stronger precautions at the international level, too, to face up to this “new breed of bank run”?

Yes, we have to find an answer to this internationally. That is why we now want to address this issue at the G7 summit in Japan. 

But how might banking supervisors respond to rapidly spreading online rumours that a bank has run into trouble?

Fake news and disinformation online singling out one particular bank can be countered by posting targeted and very rapid corrections. The bank can take care of that itself, but supervisors will also need to act in an emergency. That can only serve as a first line of defence, however.

I’d like to return to one aspect of the interest rate situation. Previously, there was increased focus on how the short-term policy rate could also have an impact up to the long end of the yield curve. Does that still matter at all in today’s monetary policy debates?

I believe it is still of key importance. Just as an example: it would make no sense for us to raise short-term interest rates while at the same time dampening long-term interest rates further by reinvesting bonds. That’s why running down the balance sheet was so important to me in the latest ECB decision. By shrinking central bank balance sheets, we are also winning back room for manoeuvre, which will enable us to respond to future crises.

If the ECB runs down its bond holdings over a period of many years, will this have a major impact on long-term interest rates? 

We have started the run-off process very moderately. The market has to be able to tolerate the pace. But I am pleased that the pace will be increased in July.  

But the Eurosystem doesn’t dare to run down its bond portfolios more quickly? After all, the Bank of England is actively selling bonds. Ms Lagarde recently said that it will now take 12 to 15 years for the ECB to run down its entire bond portfolio … 

To make a meaningful comparison, the full picture should be considered: it’s also a question of scaling back other monetary policy instruments. For example, banks are also paying back their long-term loans to us. Overall, our balance sheet is shrinking at a faster pace than that of the United Kingdom or the United States. 

One consequence of the balance sheet reduction is that attempts to green the central bank will be put on hold for now. If the ECB is no longer purchasing corporate bonds, it won’t be able to take green criteria into account. Is this going to be shelved altogether now?

No, other measures such as the adjustment of the collateral framework and climate-related disclosure requirements will remain in place. We also need to discuss whether and how we can align existing bond holdings with green criteria, even during the run-down process. One thing is clear: price stability takes priority in all of this.  

Do you have any idea of how long the German public will have to continue living with these high inflation rates? Will things be back to normal by next year?

Inflation will come down markedly, but it may well be the beginning of 2025 before the harmonised inflation rate in Germany has sustainably returned to two-point-something. We need to reach a sufficiently high interest rate level to combat the high inflation in the euro area. And once we have reached that level, we will presumably have to stay there for some time.  

Ms Lagarde also made that very clear after the most recent interest rate meeting. I got the impression that it was not your – Joachim Nagel’s – interest rate decision that was being announced, but that it was your – Joachim Nagel’s – style of communication with which it was presented. Was that the case? 

It was a joint decision of the Governing Council of the ECB. ECB President Christine Lagarde understands how to combine the various views of the Council members and then communicate the Council’s decision succinctly.   

Are some countries already saying that inflation where they are has now come down to a level that they are actually comfortable with, and that they don’t need to do much more?

Inflation rates in the individual euro area countries differ greatly: for example, in Luxembourg, inflation is below 3%, whereas in the Baltic countries, it remains in double digits. Wage developments also differ in individual countries. Overall, though, we do not discuss inflation from a national perspective. 

Are you worried that the high wage agreements in Germany could fuel inflation?

Businesses will pass on part of the increased wage costs to consumers via prices. But I think that will happen on a scale that will still be manageable. Thus far, we haven’t seen higher prices and wages driving each other up. Moreover, the Bundesbank traditionally does not interfere in wage negotiations. However, all stakeholders should be aware that monetary policymakers will do everything necessary to bring the euro area inflation rate back to 2%. 

There have recently been debates as to whether high corporate profits have also contributed to inflation. Is this really an issue, or does it only interest economists of a certain political leaning?

We are also seeing price effects emanating from the profit side of businesses in various sectors. Price setting is currently different to how it was before the pandemic. We cannot afford to have any blind spots. 

How are the US Federal Reserve’s interest rate decisions currently affecting the ECB’s interest rate policy?

There is no direct correlation between the two. We do not follow the Fed: we pursue our objective of price stability in the euro area. But of course, many and varied interactions do come into play, even simply via the exchange rate of the euro against the dollar.

Do you track inflation in the prices of any of your personal purchases?

Certainly. I often do the shopping for our family’s weekend breakfast. I get things like eggs, chocolate spread and butter. So far, inflation in food prices is still high – take eggs, for example. But I’ve noticed that while butter became very expensive last year, it is now cheaper again. Overall, the peak of inflation is behind us.