Strict warnings from Lagarde for bond and real estate purchases

By Leonidas Stergiou

For two hours, MEPs have been trying to extract a word about what will be included or when the new instrument of intervention prepared by the European Central Bank for the bond market will be announced, without, however, achieving anything but receiving two Assurances from Mrs Lagarde: First, that the normalization of bond markets is essential for the transition to monetary policy to be implemented equally effectively in all Eurozone countries. Second, that anyone who does not believe in the effectiveness of the new tool will not benefit.

Responding to questions from MEPs on monetary policy, the head of the ECB, Christine Lagarde, acknowledged that the forecasts and the description of inflation as a temporary phenomenon were wrong, which is 85% due to the unpredictable spike in energy prices triggered by the side effects of the war in Ukraine. Once the ECB realized that inflation was consolidating and exceeding the 2% target in the medium term, the central bank had to decide on a monetary policy change, even though it was aware of the risks that could arise in economic activity and bond markets.

An increase in spreads was predicted

That is why, he said, he had been warning of a return to monetary policy since December, starting with the reduction and ending of net bond purchases through the program (APP). However, it left open the flexibility of the other PEPP bond market program, as the ECB was aware of the potential for turmoil in bond markets, especially in high-debt countries. The steps towards the new monetary policy were presented in March and confirmed in June, with new details to follow. Cause; The different footprint of the pandemic in terms of costs to households, businesses and budgets, from country to country.

At this point, Ms. Lagarde made it clear that raising interest rates is necessary for price stability, but in a way that works for the benefit of all Eurozone member states. Because, the pandemic has still left its mark on the economies, in different ways and degrees from country to country. This is also due to the different impact of monetary policy change (closing the bond market and raising interest rates) on growth and funding sources, such as bond markets.

Rising interest rates

The data so far show that in June it will be decided to increase interest rates by 0.25 of the unit. A new increase will be decided in September, the amount of which will be determined by the new quarterly forecasts of the ECB. Then, he said, interest rate hikes will continue, based on current data.

Salary increases

One parameter that triggers inflation remains energy, while another that has emerged since the beginning of the year is wage increases. These relate both to the increases in the minimum wage, which have been advanced by many European countries, and to the negotiations, which show adjustments of around 3% (on average) in 2022, ie above the medium-term inflation target. In fact, she said that the effects of the increases that have been decided have not yet been measured, nor is it easy to determine the effects of those that will be decided, given the different characteristics of each economy.

Therefore, Ms. Lagarde said, the ECB is called upon to reduce inflation through monetary policy measures that increase the already enhanced risks to the macroeconomic environment. This requires a new intervention tool, which will be effective in tackling the problems of any market.

The message to those trying the ECB

“No matter how hard you try, no matter how you ask your questions, you are not going to get the word out about the new mechanism. All I have to say is that the ECB is obliged to control inflation and it will succeed. “To achieve this, we need normalization in the bond markets. Whoever does not believe in it, this will not be to his advantage,” he said.

This statement complements the information provided by ECB member Isabel Schnabel, who made it clear that the new tool would correct speculation cases, ie where the increase in spreads is not justified by the basic figures. In fact, it should prevent such cases.

Environment of increased risks

The second half of the debate in the European Parliament focused on the risks of the financial system and the macroeconomic environment. Now, from her position as chair of the European Systemic Stability Council (ESRB), Ms Lagarde has said that new risks have emerged since the beginning of 2022 and it has become clear that we are moving in an environment of increased risk.

This new environment of increased risks has brought to the ECB the need to create extreme scenarios, in addition to creating a basic and unfavorable scenario. It is recalled that the latest forecasts of ECB economists are accompanied by the basic and unfavorable scenario, as in the past, but also by estimates for more extreme situations. These scenarios, for example, calculate how much the inflation forecast will be affected if the estimate for the price of oil has fallen by 10%, or 40%, etc.

The latest forecasts of the ECB extreme scenario predict a recession of 1.3% in 2023.

These risks are mainly identified:

First, in the uncertainty about the profitability of banks, due to the indirect effects of the war in Ukraine, through the macroeconomic environment.

Second, in the assets of the banks, with the main sources being the bond markets and the real estate market. The combination of falling real estate and bond prices could lead to a reduction in banks’ assets. Decreasing loan servicing capacity can lead to an increase in red loans. Data to date do not show a decline in red loans across Europe. However, in countries where floating interest rates are predominant, mortgages may be under pressure due to rising financing costs.

Third, in cybersecurity. 2021 saw a resurgence of cyberattacks, with about $ 1 billion lost in the third quarter, according to data from the IMF and the Bank for International Settlements presented to the European Parliament.

Fourth, on climate change. Banks now have to weigh the risks to which they are exposed based on the sectors and businesses they lend to, according to how vulnerable or dependent these sectors are on energy, natural disasters, etc.

Fifth, cryptocurrencies, where the MiCA Directive is promoted. A new meeting with the Commission has been set for 30 June to create a single directive on cryptocurrency issuers, platforms, licensing, control and anti-money laundering.

Bank profitability

In terms of bank profitability, the new environment is characterized by rising interest rates and rising inflation, which are burdening growth, while a war is underway. The baseline scenario predicts that inflation will be controlled and that growth will continue to be positive despite any slowdown.

Real estate market

But, as she said, in such an environment one can not ignore the extreme scenarios. One of them predicts that inflation and interest rates may reduce the demand for loans, reduce mortgage financing, reduce the ability of households to service loans due to declining disposable income, as energy prices will remain high. .

Overpriced markets

In such a case, the reduction of demand in the real estate market can not be ruled out, which will lead to price correction, especially in countries where there have been large price increases. These countries have already been monitored for risks from the real estate market and specific recommendations have been made to the banks by the ECB. These are Luxembourg, Austria, France, Germany and Portugal, as well as Slovakia and the Netherlands, which have moved to the “overrated” zone in the last two years.

Greece

Greece is not included in the countries that pose risks in the real estate market, not even in those that are close to the danger zone, mainly due to the previous big drop that had preceded. Greece, along with Slovenia, Estonia and Finland, is in the group of markets that present fairly “fair” real estate prices.

In this context, Mrs Lagarde called on the European Parliament to support the ECB proposal, which, together with the Commission, will promote a single European framework for the real estate market and its financing.