Simonas Krėpšta: Work for central bankers is not done yet

Marek Pielach, Obserwator Finansowy: Thank you for accepting our invitation. Before we move to the questions about Lithuania, I would like to start with a more general one: I am curious about your opinion as to where we are in the global monetary cycle. Should we be more worried about the risk of under- or over-tightening now?

Simonas Krėpšta: First of all, thanks for having me here. It’s a pleasure to be here in Toruń and participate in this interview. Talking about the monetary policy, I think, looking at the Eurozone, we now see that interest rates are 2.5 per cent, which is not a very high level if we look at broader historical examples. Yet the inflation rate is more than 8 per cent and it is a very high level, also from a historical perspective. So it means that the work for central bankers is not done yet regarding interest rates and other measures which tighten monetary policy. There is still more work to be done to avoid the long-term de-anchoring of inflation expectations, which could have negative feedback loops: inflation-wage growth spirals and so on. I think we are moving in a cautious manner. We look at the data every time very carefully, we are flexible and we take quite small steps but firm steps towards the future and let’s see what happens next. The ECB intends to raise the rates by 50 basis points during the next meeting in March and after that, of course, we need to reassess the data in detail and look forward.

You mentioned the March meeting of the ECB. How will you determine the desirable interest rate level that would allow inflation to return to the target? Even after March, what will be the endgame of the interest rates in euro?

Of course, the ECB is very much a data-driven organisation. We receive new data every month, we assess it very carefully and then we weigh our decisions for the future in a very balanced manner. You know, there are many factors. We got some good news about inflation this month and last month, January and February. We saw inflation numbers falling more sharply than it had been expected before. At the same time, we see that the economy is holding quite strong and we even see some positive estimates which recently came from the European Commission. They expect the economy to grow more than they expected previously. So we will see what the data will bring, but for now we can say that the rates should go up compared to the situation we have now. They’re still quite low and they need to be raised at least a couple of times to firmly de-anchor the inflation expectations and to be sure that we are bringing inflation back to the two per cent target over the medium term.

Speaking about GDP, is the recession in the euro area in 2023 no longer the baseline scenario after the warm winter and decline in gas prices?

In December, the ECB forecasted a mild recession for the first half of this year, but over the last couple of months we had some positive news in a sense. So yes, one factor is a mild winter, and another is the abating energy crisis. We see that energy prices have fallen quite a lot – they’re still more elevated than they used to be a couple of years ago, but they have fallen more sharply than we expected a couple of months ago. They have decreased more sharply compared to the forecasts we made in December, so that’s good news. And yes, I think now there certainly is a bigger chance of avoiding recession compared to the situation we saw a couple of months ago. But of course the future is very uncertain – it has been uncertain for the last couple of years. I think it will remain uncertain this year as well, so anything can happen.

In January, inflation in Lithuania was on the decline, yet it continued to run at 20 per cent. What is the economic reality of Lithuania and also the other Baltic states? Will these economies hold up even if the war in Ukraine continues, for example, for a few more years?

Yes, we reached our inflation peak in the last quarter of 2020 and our inflation figures were well above 20 per cent, but for the last four months already we have seen declining inflation figures and the latest January number was 18 per cent, which is not much more than what you have in Poland. So I think that the trend is quite good and we at the Bank of Lithuania estimate that inflation could reach single digits in the middle of this year, so we see a clear downward trend. And in terms of the economy, I think – again – it seems to be really resilient. It absorbed the shocks we experienced a couple of years ago – the pandemic – but more recently, last year, the brutal Russian war and the energy crisis. Still, our economy grew by 2.2 per cent in 2022, which is quite a healthy number given the circumstances and the adverse shocks we had last year. For this year, we expect slower growth, around one per cent, but still not negative growth. In general, I think the economy is resilient given the circumstances and certainly our society in Lithuania clearly sees what is happening in Ukraine. Compared to that I think we are really doing well and we don’t see any huge tensions in society regarding the state of the economy at the moment.

Bloomberg’s infographic suggests that the governor of the Bank of Lithuania is one of the ECB’s hawks. I want to ask: is it hard to convince the governors from the southern part of Europe, where debt is a bigger problem, to tighten the monetary policy?

Well, I think there is a very clear and firm agreement within the Governing Council about what our goal is and it is to bring inflation back to the two per cent target over the medium term and to have price stability, which is the bedrock of stable economic growth, social growth, the labour market and so on. I think we do not have any big disagreements in this regard. Where there is discussion, it’s about what kind of measures to use and what policy stance to take to reach this goal. But again I think it’s very good to have a lively debate, it’s very good to have different opinions and as I know these discussions are very rich, but at the end of the day a decision is made, most of the time unanimously in terms of consensus, and we see clear steps. From the middle of last year the base rates were increased by 300 basis points, from minus 0.50 per cent to 2.5 per cent at the moment. We saw other measures of policy tightening, which is going on, and there is a commitment to be firm and take firm steps into the future.

Considering the lack of cohesion of the euro area for this inflation level and also GDP, should central banks act through interest rate decisions or should they use other instruments as well?

Well, central banks and especially the European Central Bank have many tools in their toolbox and actually the first monetary tightening tool was triggered as early as the last months of 2021, when we decided to slow the APP amounts. But of course, rates are the major tool, which was used in the middle of last year, and we see that this is the tool which has the biggest effect on monetary conditions and financial conditions.  We see some clear signs of slowing inflation but we also see that financing conditions are becoming tighter and we see that lending conditions are also getting tighter, which again will affect economic growth and the demand side and will hopefully reduce inflation further down the road.

The interview was held on the 20th of February 2023.