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Interview of the Bank of Greece Governor Yannis Stournaras with Financial Times

18/10/2023 - Articles & Interviews

Middle East crisis casts shadow over ECB meeting

Martin Arnold in Frankfurt and Eleni Varvitsioti in Athens

Bank of Greece Governor Yannis Stournaras says Israel-Hamas war bolsters the case for keeping rates on hold

The Israel-Hamas war is creating new challenges for Europe’s economy, from energy market disruption to an influx of refugees, Greece’s central bank Governor has warned.

Yannis Stournaras told the Financial Times that the turmoil in the Middle East shifted the balance against any further tightening of monetary policy.

“It is a question of common sense,” Stournaras said a week before he will host a meeting of the European Central Bank’s governing council in Athens. The meeting is widely expected to yield no change in eurozone interest rates for the first time in 15 months.

“If you have a new source of uncertainty in the Middle East, where it is totally unknown what is going to happen — we are in the dark — it is better to keep all of our options open and be careful to retain the resilience of the European economy,” he said.

The Israel-Hamas conflict has contributed to a moderate rise in oil and gas prices. That has led to concern of a fresh wave of inflation. But Stournaras said the ECB should avoid any “knee-jerk reaction”.

“Taking into account the fact that the eurozone continues to be a large net energy importer, it is likely to have a stagflationary impact if it becomes a problem,” he said, adding that “a humanitarian crisis” in Gaza could also cause a surge in refugees arriving in Europe.

“We have to be prepared; if there is an exodus of people, we know by definition that Europe and the European south is going to be the first stop, so that is going to be a serious economic and social problem,” he said.

The eurozone economy is already at “a critical point where if we continue to raise interest rates we run the risk of something being broken”, he said. “There is a lot of progress where inflation reduction is concerned, we are almost stagnant in eurozone activity and we have experienced a reduction of lending by banks.”

The ECB has raised its benchmark deposit rate from a record low of minus 0.5 per cent to an all-time high of 4 per cent to tackle the biggest inflation surge for a generation.

Asked when he thought the ECB could start cutting rates, Stournaras said: “If inflation in the middle of next year . . . falls close to 3 per cent, that is perhaps the time to start thinking about a rate cut.”

Eurozone inflation remains more than double the ECB’s 2 per cent target, but a reversal of energy prices helped it drop to almost a two-year low of 4.3 per cent in September. Core inflation, which excludes energy and food to give a clearer picture of underlying price pressures, is also the lowest for more than a year at 4.5 per cent.

Even some of the more “hawkish” ECB council members have started to indicate rates are high enough. Klaas Knot, head of the Dutch central bank, said at a recent conference he was “comfortable with the current stance of policy . . . we are now getting on top of inflation”. Croatia’s central bank chief Boris Vujčić said: “What we are seeing now is a soft landing.”

Some hawks have shifted their focus to calling for the ECB to speed up the shrinking of its vast bond portfolio by stopping reinvestments in its €1.7tn Pandemic Emergency Purchase Programme, or PEPP, earlier than planned at the end of next year.

Stournaras said there were “pros and cons” to the idea and he expected it to be discussed next week. But he said the PEPP was the ECB’s “first line of defence” against a divergence in borrowing costs between eurozone members. “At this stage, given everything going on in the world, isn’t it better to retain our flexibility?” he said.

He also expressed concern about the recent sell-off in bond markets that has pushed up borrowing costs for governments. “I worry when I see countries with deficits above 6 or 7 per cent of GDP — it reminds me of the Greek crisis,” he said. Italy’s budget deficit was 8 per cent of GDP last year and Rome expects it to fall to 5.3 per cent this year.

The ECB’s first council meeting in Athens since 2008 underlines how Greece has gone from Europe’s Achilles heel, which needed bailing out during its sovereign debt crisis a decade ago, to one of the region’s best-performing economies.

This year it regained an investment grade credit rating.

Yet Stournaras, who was Greece’s finance minister during its debt crisis, said the country must increase its primary surplus — excluding debt costs — from 1.1 per cent this year to more than 2 per cent next year, a goal that might prove challenging given the state of the European economy.

Greece’s debt is the largest of any EU country at 171 per cent of gross domestic product last year. But it is expected to fall to 152 per cent next year thanks to the primary budget surplus and the boost from inflation to nominal growth. Athens is also insulated from rising borrowing costs because low rates were locked in until 2032 under its bailout.

The country’s growth is, however, threatened by its shrinking population. “Many organisations like the IMF, in the very long run, think that the Greek growth rate would fall by 1 to 1.5 percentage points because of a declining population,” said Stournaras. He urged the government to boost productivity by reducing judicial delays, speeding up digitisation of the public sector, and improving the quality of schools, public transport and hospitals.

Officials in Athens are counting on more than €55bn in EU funds in the next six years to support public investments. “The Greek government should continue with the reform agenda and fiscal consolidation,” he said. 

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