Luis de Guindos: The euro area economy and the energy transition
Speech by Mr Luis de Guindos, Vice-President of the European Central Bank, at the
Energy Prospectives event, organised by IESE (Escuela de Negocios de la Universidad
de Navarra) Business School and Naturgy Foundation Madrid, 4 November 2022.
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I am very pleased to be taking part in this event on the important topic of the energy
transition and its impact on the economy. Following the monetary policy decisions taken
by the ECB's Governing Council last week, I will start by providing an overview of the
euro area economic outlook that underpinned our deliberations. I will consider the
impact of energy price developments on inflation before discussing the green transition
and how climate change is taken into account in our monetary policy framework.
Euro area economic outlook and energy price developments
Growth in the euro area is estimated to have slowed down significantly in the third
quarter of this year, with real GDP growing at 0.2%. High inflation continues to dampen
spending and production throughout the economy. Severe disruptions in the supply of
gas have worsened the situation further, and both consumer and business confidence
have fallen rapidly. Demand for services is decelerating following the strong rebound
that came with the reopening of the economy over the summer, especially in tourism.
The continued weakening in global demand, also in the context of tighter monetary
policy in many major economies, and the worsening terms of trade mean that there is
less support for the euro area economy.
Inflation continued to rise, reaching 10.7% in October, driven by further increases in all
its main components. Supply bottlenecks have eased but their impact is still gradually
feeding through to consumer prices, as is the impact of pent-up demand in the services
sector. The depreciation of the euro has also added to the build-up of inflationary
pressures. Price pressures are evident in more and more sectors, in part owing to the
impact of high energy costs feeding through to the whole economy. More than half of
the items in the Harmonised Index of Consumer Prices (HICP) have recorded inflation
rates above 4% and measures of underlying inflation have remained at elevated levels.
In particular, inflation excluding energy and food rose further, to 5%, in October.
To support the timely return of inflation to our 2% medium-term target, our monetary
policy aims to reduce support for demand and to ensure that inflation expectations
remain anchored at our target. Last week we decided to raise the three key ECB
interest rates by 75 basis points - the third major rate hike in a row - and we expect to
raise interest rates further. We also changed the terms and conditions of the third series
of targeted longer-term refinancing operations (TLTRO III) to ensure that its calibration
is consistent with the broader monetary policy normalisation process and to reinforce
the transmission of our policy rate increases to bank lending conditions. Finally, we
decided to set the remuneration of minimum reserves held by credit institutions with the
Eurosystem at the ECB's deposit facility rate since, in the current circumstances, it
better reflects the rate at which funds can be invested in money market instruments or
borrowed in money markets to fulfil minimum reserves.
But let me return to inflation and its components. Energy price inflation - at 41.9% in
October - remained the dominant driver of overall inflation. It caused a pronounced rise
in inflation in the course of 2021 and at the beginning of 2022. While the initial rise in
energy prices was driven mainly by the recovery in energy demand as lockdown
measures were being eased, the subsequent price rally during 2021 was also
significantly influenced by supply-side issues and later exacerbated by the Russian
invasion of Ukraine.
European gas prices have increased particularly sharply since the summer of 2021.
This reflects a combination of supply and demand factors that left European gas
inventories at historically low levels and the gas market vulnerable to supply and
demand uncertainty. As a result, consumer gas and electricity prices - both driven by
natural gas prices - have played an increasingly important role in energy inflation
dynamics. European gas spot prices have dropped strongly over recent weeks, owing
to a variety of factors. These include weakening gas demand due to the mild near-term
weather forecast, high storage levels, and a higher supply of liquefied natural gas and
pipeline gas from Norway, as well as initiatives at national and EU level to curb gas
demand, support supply and cap prices. However, the drop in gas futures prices has
remained much more contained than the drop in spot prices, suggesting that the supply
situation is still fragile.
Looking further ahead, while supply bottlenecks are expected to ease further, the
energy shock is expected to increasingly weigh on activity and inflation. Rising energy
prices are expected to squeeze real disposable income and dampen production. At the
same time, we may still see delayed pass-through of the past increases in wholesale
energy prices to consumer prices which, together with recent geopolitical events, point
to continuing upward pressures to the inflation energy component.
The ECB's climate change commitments
The unprecedented energy price developments and the ensuing energy crisis are
posing challenges in various ways. In fact, a trade-off between energy security, the
green transition and price stability may be emerging.
Despite the current monetary policy challenges, the ECB is seriously committed to
doing its part to address climate change and promote the green transition, as this is
necessary to fulfil our price stability objective.
Climate change can have an impact on macroeconomic indicators, the stability of the
financial system and the transmission of monetary policy. All these channels affect the
outlook for price stability.
Climate change also has a bearing on the ECB's own risk management. Our monetary
policy operations have encompassed asset purchases, which now appear on the
Eurosystem's balance sheet. Counterparties to our lending operations must pledge
assets as collateral against the money they borrow. We need to consider the impact of
climate change on the value and the risk profile of these assets to ensure that it does
not jeopardise the achievement of our monetary policy objectives.
Furthermore, without prejudice to our primary goal of safeguarding price stability, a
secondary objective of the ECB is to support general economic policies in the EU.
These include a high level of protection and improvement of the quality of the
environment, in line with the EU's climate neutrality objectives. This means that if faced
with a choice between two policy options that have a comparable impact on price
stability, we should choose the option that better supports the secondary objective.
In the strategy review we completed last year, we committed to including climate
change considerations in our monetary policy operations. More concretely, we have
decided to (i) adjust corporate bond holdings in our monetary policy portfolios, (ii) limit
the share of assets issued by non-financial companies with a high carbon footprint that
can be pledged as collateral by individual counterparties, (iii) introduce climate-related
disclosure requirements in our collateral framework, and (iv) enhance our risk
assessment and management.
The aim is to gradually decarbonise our corporate bond holdings, on a path aligned with
the goals of the Paris Agreement. In practice, this involves measuring the climate
performance of each eligible issuer based on its greenhouse gas emissions, carbon
reduction targets and climate-related disclosures. Ultimately, this will result in the
purchase of more bonds issued by companies with a good climate performance and
fewer bonds from those with a poor climate performance. This tilting changes the
composition of the monetary policy portfolio, but the overall purchase volume is still
determined solely by monetary policy considerations - in line with our primary mandate.
This process is already under way: as of 1 October we have started to tilt our
reinvestment purchases towards issuers with a better climate performance. And from
the first quarter of 2023, we will start to publish climate-related information on our
corporate bond holdings.
To enhance our risk assessment and risk management, the ECB is conducting a
climate stress test on the Eurosystem's balance sheet, starting with the corporate
holdings, to be finalised in the first half of 2023. The stress test builds on the
methodologies developed for the previous climate stress testing exercises, in particular,
the ECB's economy-wide climate stress test, which assessed the impact of physical
and transition risks on the corporate loan portfolio of the euro area banking system, and
the supervisory climate risk stress test, conducted with the involvement of the banks.
Conclusion
Let me conclude. The current energy crisis has left Europe at a crossroads, presenting
challenges as well as opportunities for the green transition. The Russian invasion of
Ukraine and the subsequent reduction of fossil fuel supplies have imposed a potential
trade-off between energy security, the green transition and price stability.
With inflation currently at elevated levels and expected to stay above our target for an
extended period, monetary policy must remain focused on reducing support for demand
and guarding against the risk of a persistent upward shift in inflation expectations. The
longer inflation levels stay above our target, the greater the risk of second-round effects
- through wage increases or the de-anchoring of inflation expectations. Amid the
present uncertainty, future decisions on policy rates will continue to be data-dependent
and follow a meeting-by-meeting approach.
To keep the green transition on track, concrete policy actions are needed to make the
most of the opportunities provided by the current energy crisis. Expanding the share of
renewable energy supplies would reduce dependency on fossil fuels. It would also
benefit price stability, given the declining prices for renewable energy observed during
the past decade. In addition, to bring down energy costs sustainably over the medium
term, governments should act to dismantle the regulatory barriers preventing the uptake
of renewable energy, prioritise upgrading the electricity grid and foster investment in
renewables. An important role for fiscal policy is to support the green transition via
public green investment.
To counter the sharp rise in energy prices, many governments adopted expensive and
broad-based support measures for households and firms. But these measures risk
diluting relative price signals that are crucial to incentivise energy saving and foster
green investment. Instead, government support should be temporary and targeted
towards vulnerable households and firms. This would also help to limit risks to fiscal
sustainability.
Fiscal policy and monetary policy need to work hand in hand. In view of the
normalisation of monetary policy, it is essential to achieve a good balance between
supporting energy security and ensuring price stability, while keeping the green
transition on track.