Joachim Nagel: Uncertain times - banks need resilience
Speech by Dr Joachim Nagel, President of the Deutsche Bundesbank, at the Deutsche
Bundesbank's symposium "Banking supervision in dialogue", Frankfurt am Main, 8
November 2022.
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1 Introductory remarks
Ladies and gentlemen,
Welcome to this year's Bundesbank symposium "Banking supervision in dialogue". A
special welcome goes out to Andrea Enria. This event is a first for both of us this
morning - for Andrea as a speaker, and for me as President of the Bundesbank. What
a relief, then, that much else is familiar to me. For instance, my Executive Board
colleague Joachim Wuermeling is hosting this event for the third time already. He is
taking the floor straight after me. What's more, many of today's attendees have
participated in this Bundesbank symposium in the past. For many of you, it is one of the
firm fixtures on your calendars for the year. However, the pandemic forced us to take a
two-year hiatus from this straightforward, direct exchange of ideas. Happily, we've now
moved on from that.
You see, it is particularly in times of great uncertainty that personal interaction comes to
the fore. It helps to strengthen one's own powers of judgement. This holds especially
true in times when we are also seeing our economic models coming up against their
limits. Indeed, judgement was a topic raised at the press conference following the ECB
Governing Council's monetary policy meeting at the start of September. At that
meeting, Christine Lagarde was taken to task for the repeatedly inaccurate forecasts
produced by ECB staff. It is true that our experts at the Bundesbank, too, were caught
unawares by the pandemic, the war in Ukraine and what Christine Lagarde referred to
as "the energy blackmail". But even so: repeatedly underestimating inflation dynamics
is more than unfortunate. It is vital that we get to the bottom of what caused this
problem. Addressing the forecasting difficulties, the ECB President referred - quite
rightly, in my view - to the importance of judgement, saying that: "We also apply as
much judgement as possible to be as accurate as we can".
However, judgement is formed through experience. Sharing experience and leveraging
those insights to advance one's own assessments - that is the whole idea behind this
Bundesbank symposium. This morning's session is all about the status quo for banks -
the smaller institutions and the big ones. Big or small - they all find themselves
operating in a fundamentally altered environment. One that is characterised by the
reversal of interest rates and by economic prospects that are not just gloomy but
exceptionally uncertain as well. I'd like to begin by briefly outlining those prospects. You
will notice that the theme of uncertainty is a leitmotif running throughout my remarks.
2 Economic activity and inflation
Germany's economy was still in good shape going into the summer. Economic output
was almost back at its pre-pandemic level in the second quarter. And in the third
quarter, too, pandemic-related re-opening effects were probably still shoring up
economic activity. However, high inflation and uncertainty surrounding the energy
supply and the costs thereof dragged increasingly on the German economy. Retail
trade suffered real declines. Activity in the construction sector slowed down. In view of
the high gas prices, efforts were made to save gas, particularly in industry. In some
sectors, production was cut back and, in part, relocated.
Despite these headwinds, gross domestic product still posted a slight increase in the
third quarter, climbing by 0.3% on the quarter according to the Federal Statistical
Office's flash estimate. However, sentiment deteriorated sharply as the third quarter
progressed: at enterprises across all sectors and among consumers. Indeed, the
consumer climate index fell to a new record low. The gas supply situation is currently
better than expected - gas storage facilities are well filled, I'm pleased to say. At
present, our Bundesbank experts are leaning towards not expecting outright rationing in
Germany this winter. It could still be a close call, though, depending on how the weather
and consumption patterns play out. Incentives to save gas are therefore still as
important as ever. High energy costs may, however, cause output to decline further,
particularly in industry. The recent downbeat production plans and export expectations
in industry are consistent with that view. Moreover, the considerable losses in
purchasing power and households' subdued mood for spending are likely to lead to a
drop in private consumption. Service providers whose businesses are heavily
dependent on private consumption will probably bear the brunt of this. Economic output
could fall significantly overall in the final quarter of 2022 and first quarter of 2023.
This would mean we would be faced with a recession, i.e. a significant and
longerlasting decline in economic activity spread across the economy. The scale of this
decline would depend on many uncertain factors. For instance: households' gas saving
behaviour, winter temperatures and policy measures. One thing is for sure: gas
shortages would amplify downward forces. IMF experts are expecting the German
economy to shrink next year, with a decline of 0.3% anticipated. As for the euro area as
a whole, the impact of the energy crisis will likely be somewhat weaker than it will be on
Germany. The IMF is expecting euro area GDP to grow slightly next year, by 0.5%.
Economic activity in the euro area is being hampered not only by tensions in the energy
market but also by exceptionally high inflation. The substantial upward pressure on
prices is broad-based. It is dragging on private consumption, in particular. In Germany,
inflation rates have been in the double digits since September and are at a 70-year
high. Inflation as measured by the HICP is expected to be above 8.5% in 2022. This is
largely due to the Russian war of aggression against Ukraine and its consequences,
which I have already outlined. However, inflation was already on a strong upward
trajectory even before the war broke out, what with the global economy recovering
unexpectedly quickly from the coronavirus crisis. Inflation in Germany will probably
remain high next year, too. I believe it is likely that, on an annual average in 2023, the
decimal point will be preceded by a seven. And the risks are clearly tilted to the upside
given the tensions in energy markets. It also remains to be seen what the gas and
electricity price brake will look like and to what extent it will directly curb prices. In any
case, inflation in Germany is therefore likely to remain elevated for some time to come.
It's a similar situation in the euro area. This year, consumer prices have risen time and
again at rates not seen since the introduction of the euro. At an estimated 10.7%, the
October rate was the sixth all-time high in a row. Price pressures are broad-based at
the euro area level as well. Core inflation stood at 5.0% in October. And for the next two
years, the inflation forecast last published by the ECB provides figures that are
noticeably above our medium-term inflation target of 2%, namely 5.5% for 2023 and
2.3% for 2024. However, the forecasts should be interpreted in caution, which is a
problem that I have already touched upon. First, tensions in energy markets could
persist for longer than assumed in the forecasts. Second, the still high commodity
prices could be passed on to consumers to a greater extent. And third, wages could rise
more strongly than expected, partly in response to inflation surprises.
3 Monetary policy
In view of these price developments and the outlook for inflation, the ECB Governing
Council has acted decisively. It has taken the first steps towards normalising monetary
policy. In July, we set the interest rate reversal in motion. We raised key interest rates
by 0.5 percentage point and brought the chapter of negative deposit rates to a close. In
September and October, we followed this up with even larger interest rate hikes of 0.75
percentage point. Further interest rate increases are necessary to bring the inflation
rate back to 2%. The size of each interest rate step and how high we will raise the rates
will depend on how the data and outlook develop. However, monetary policy
normalisation is about more than just raising key interest rates. The ECB Governing
Council will also look at the large holdings of bonds. These currently stand at almost
€5 trillion. And they continue to push euro area bond yields down significantly.
All of these monetary policy measures are able to curb inflation - not immediately, but
with a lag. In any case, as the Governing Council of the ECB, we must ensure that the
high rates of inflation come to a swift end. Ultimately, there is no question that the
longer inflation remains high, the higher the risk that longer-term inflation expectations
will rise. It would then be all the more difficult for monetary policy to restore price
stability. And this would increase the risk of inflation becoming entrenched at a high
level over the medium term. The Eurosystem has a mandate to maintain price stability. I
will therefore continue to do all I can to ensure that we, as the ECB Governing Council,
do not - under any circumstances - let up too soon, that we press ahead with monetary
policy normalisation with determination - even if our measures dampen economic
growth. Because in a situation where monetary policy lags behind the curve, the
macroeconomic costs would be significantly higher.
4 Banks in Germany
Ladies and gentlemen, what must be going through your mind right now when you, as
representatives of banks, hear about the determination to resolutely normalise
monetary policy? Maybe you are imagining a multi-layered risk scenario starting to
unfold? You are probably thinking of the risks associated with inflation and the reversal
of interest rates. And also the risks arising from economic developments. Given the
economic outlook I described, some enterprises could be facing rougher seas going
forward. Furthermore, they are also confronted with higher production costs due to
inflation. And higher interest rates are driving up their financing costs. This increases
the risk that enterprises will no longer be able to service their debt as reliably as they
have over the past few years. And alongside cyclical risks, operational risks also
remain. Risks from the digital sphere, from levels of sickness among staff, from
potential power outages, to name just three possible scenarios. These operational risks
will be on the agenda of this symposium this afternoon. We must not lose sight of these,
either. They must be managed just as prudently as cyclical risks. This is demanded by
supervisors, and rightly so, to strengthen the resilience of banks.
But resilience also requires a sound capital base. Banks proved to have this in the past
stress tests. This is good news. Because our economy needs strong banks to meet its
huge need for investment. Advancing digitalisation needs financing. And so, too, does
the transition to a carbon-neutral economy with a stable, secure energy supply. Banks
have a key role to play here. They are currently fulfilling their financing function
prudently.
The most recent Bank Lending Survey found that the responding German banks had
considerably tightened their lending policies in the third quarter. This is also a response
to the increased credit risk perceived by banks. However, thus far, there has been no
evidence of the supply of credit being restricted in general. Instead, lending to
nonfinancial corporations was strongly expanded once again. It is important that banks
continue to strengthen their capital base and prudently manage their risks in order to
remain resilient. This will enable them to effectively fulfil their vital financing role in the
economy in future, too. Even in uncertain times.
5 Conclusion
Ladies and gentlemen, times are uncertain. Interacting with others is hugely important
here, especially with regard to the individual aspects of uncertainty. I hope that you
have fruitful and inspiring interactions on all of the aspects that are vital for the business
models of German banks at present. I trust that you will conclude today with a greater
and more rounded sense of judgement. And I hope that this will play at least some
small part in strengthening the resilience of your institutions. And in closing, I look
forward to interacting with you all as well.
Thank you very much.