ECB Policy Not the Time to Raise Rates

Erkki Liikanen, governor of the Bank of Finland and a member of the European Central Bank's governing council, told Handelsblatt why the ECB won't raise interest rates any time soon.
Patience is a virtue: Erkki Liikanen says the ECB needs time to recalibrate its policy for the euro zone.

You could say the 2008 financial crisis made the European Central Bank what it is today. Erkki Liikanen, governor of the Bank of Finland and a member of the ECB's rate-setting governing council, gives testament to that fact with a picture of a black swan in his office. The swan serves as a symbol of the power of events that nobody sees coming – Lehman Brothers' bankruptcy, for example.

The ECB has gathered tremendous power in the past decade since the 2008 crisis, taking over the job of monitoring the euro zone's largest banks in 2015 and buying up more than a trillion euros worth of government and corporate bonds over the past two years in a bid to keep the 19-nation currency bloc afloat. Mr. Liikanen, a former Finnish finance minister and E.U. commissioner, has helped shape the ECB's new role more than most. In 2012 he was charged with investigating how Europe's banking sector needs to change. The Liikanen report formed the basis of most of the banking sector reforms since put in place.

Now, with memories of the financial crisis slowly waning and inflation rising nearer to the central bank's target of close to 2 percent, the ECB too is pondering how to scale back how deeply it is entrenched in the European economy. Benchmark interest rates remain at a record low of 0 percent and the ECB deposit rate – a rate offered banks that park their reserves overnight with the central bank – remains at a punitive negative rate of -0.4 percent.

Mr. Liikanen, who sits on ECB governing council that sets interest rates for the euro zone, told Handelsblatt the central bank doesn't plan to increase interest rates any time soon, at least not before it ends its bond-buying program at the end of this year. There has been some speculation in recent weeks that the central bank may raise its deposit rate before the bond-buying program is done, but Mr. Liikanen said ECB council members agreed at their March meeting that rates shouldn't be raised for the time being. He likened the ECB's rate-raising exercise to a marathon, not a sprint.

That won't be music to the ears of German policymakers and savers who, with inflation on the upswing, have been clamoring for interest rates to rise sooner rather than later. Read the full interview with Mr. Liikanen below.


Handelsblatt: Governor Liikanen, when the ECB started its bond purchasing program two years ago, you compared that to a marathon. Where do we stand right now?

Erkki Liikanen: We have run a long way now and we know it works. We are seeing the positive impact on the economy. The euro area economy has turned, there is broad based growth and lending has picked up. However, we are still on a marathon and we have to finish it.

Can you see the finishing line yet?

We are going in that direction and it works as intended. But it is important to implement all the decisions we have made and to meet the commitment and intentions from December. It is like in a marathon - if you start to hesitate, you will not finish. We still need to bring price stability to close to, but below 2 percent, in a sustained manner. One issue is, of course, that you cannot count these spikes up and down. You must look ahead to what happens in the longer term. Secondly, it is also important to have a medium-term inflation target of close to 2 percent for the euro area as a whole. Some countries have been above, some countries have been below.

But wouldn't this be a good time to start thinking about an exit strategy?

We have come out a particularly difficult situation where prices were falling and deflation risks were very high at the end of 2014/2015. We have been able to turn that around. Certainly we need to start planning these issues way before we take the first concrete measures, but it’s not our main agenda today.

If we get the economy growing in the long term, it benefits us all, Germans, Finns - everybody. That is the precondition for higher interest rates.

Euro zone inflation fell to 1.5 percent in March after hitting 2 percent in February. How sustainable is the inflation trend?

According to the ECB projections, inflation will still stay below our target for 2017 to 2019. So far nothing has contradicted that outlook.

But it takes a very long time for wages to react. Wouldn't waiting until they pick up be too late ?

Of course they are not the only factor, but they are a very important factor. I don't want to single out just one indicator. We look at a broad set of indicators when we analyze the outlook for prices. Yet it’s hard to foresee sustained inflation if wages do not rise.

In Germany people are worried about inflation - it’s a hot topic. What do you tell them?

If we get the economy growing in the long term, it benefits us all, Germans, Finns - everybody. That is the precondition for higher interest rates. We just need to accomplish that mission. And we have a good track record on containing inflation in the past.

The European economy has improved. How sustainable is this improvement?

It is based mostly on consumption. But investment has also picked up thanks to the better financial conditions, which have eased. And recently we have also seen positive developments on the export side. When you look from country to country, improvements are broader than for a long time. Monetary policy has been important. Some countries have made structural reforms and improved their competitiveness. Those who have made reforms get greater benefits, and earlier. No pain, no gain!

For more than four years, the ECB has failed to deliver on its mandate. Isn't more sustainable development necessary, and maybe even overshoot the 2-percent target for a period?

Oil prices have been the main driver behind low inflation - we wouldn’t have been able to resist that with monetary policy. I do not like the word "overshoot" because it sounds as though you are pushing something up artificially. If your target is close to 2 percent in the medium term, it must be symmetric, in my mind. There can always be temporary deviations that sometimes rise above that target. You must always look ahead. The target in the medium term is below, but close to 2 percent. I have a symmetrical approach to that. If inflation is too high, we act. If it is too low, we act. But the key question is: When does it get to a level that is sustainable?

Is this symmetrical approach the consensus on the governing council?

I'm telling you what I think: Your focus must always be on the medium term. And also on the euro-area average.

That sounds quite dovish.

These terms can be misleading. In the summer I live on an island in the east of Finland and I watch the hawks. They can fly quickly up and quickly down. It's a question about how we approach the target. Whatever the circumstances, we must rigorously follow our primary target in the medium term – whether it’s up or down. That does not sound particularly dovish to me.

There seem to be different views on the ECB governing council on sequencing - at what point to exit the ultra-loose monetary policy. Some seem to favor a raise in the deposit rate before starting to phase down the bond purchases.

We have stated that rates would remain low beyond the end of the purchases. It was not contested at the time. Of course there have been some discussions about over the “present or lower” level. The option to cut rates has been kept in communication in case things get worse.

So there are not two camps?

I would say there are many opinions. That makes discussion important. We are all on the governing council in our own capacity and everybody is listened to. When the press conference starts, Mario Draghi presents the introductory statement, which we have gone through together. He also communicated the governing council’s view well during the Q&A.

If this protectionism starts taking over, that would be a major risk.

Markets have interpreted from Mario Draghi that the ECB might raise its deposit rate before it starts tapering. Have they misinterpreted him?

I never comment on markets. They may change their opinion tomorrow. We must make our policy based on our own economic analysis and strategy.

Is what the markets believe consistent with what you have discussed?

Most, if not all, agree that we need to implement what we decided in December. To purchase until the end of the year, keep the monetary policy rate low, and also the sequence that the rates remain low even after the purchases.

But the negative deposit rate is, in a way, a special tool that only some central banks have used - particularly those having problems with an appreciation of the exchange rate. Is there not a limit at which the risks outweigh the benefits?

There can always be a limit. In the euro area the real deposit rate has been at low levels before. But you have always to be very careful to assess the pros and cons.

Could there be still a change in the ECB's Forward Guidance on interest rates? Is now not the time to discuss this?

I would say one always needs to analyze is the balance of risks. You must take the incoming information into account. Last time we saw that there had been some improvement, and we said that the balance of risks had improved. Some parts of our previous Forward Guidance were taken out of our introductory statement. But the improvements we have seen so far were not enough to change the essence of our Forward Guidance. Our economy still needs this strong monetary policy support.

What are the major economic risks at the moment?

The big question is protectionism. If you study world economic history, long-term growth has always been linked to open trade. If this protectionism starts taking over, that would be a major risk. Open trade and globalization have major benefits, but one also needs to deal with the potential side effects: inequality and marginalization.

And Brexit?

Yes, it is a downside risk. I think it is the biggest challenge for the U.K. economy.

Do you see any political risks in Europe due to forthcoming elections in France and Germany, and the rise of populist parties?

If you follow the polls after Brexit, people’s attitude to the E.U. is becoming more positive. Many people think it is better to sit together and act according to agreed rules. People still think that working together with common European institutions is better than being alone. In this global world the E.U. is for many people an anchor of stability.


Jan Mallien covers monetary policy for Handelsblatt out of Frankfurt. Helmut Steuer is Handelsblatt's correspondent for northern Europe. To contact the authors: [email protected][email protected]