ECB Board Member Peter Praet warned a few days ago about the gradual convergence of inflation toward its target level, which explained the central bank’s patience and persistence. In his view, three circumstances must be met to initiate monetary normalization: convergence, confidence, and resilience in price trends. It is necessary to ensure that financial conditions are consistent with a sustained upward adjustment of inflation.
Central banks set official interest rates, but it is the market that determines the levels of the yield curve. In recent months, and especially in recent weeks, there has been an increase in the positive slope of the yield curve. It is clear that investors do not fear a spike in inflation. Nor do they anticipate an imminent rise in official interest rates, given the messages regarding gradual adjustments that are still far off in time. Investors and savers are looking for other alternatives to place their savings instead of fixed income, which currently has interest rates at historic lows and negative real returns.
Penalized by the design of monetary policy during the crisis—which focused on benefiting financing flows to companies and families—savers are now looking to benefit from growth data that is surprising on the upside. It is difficult to find a period in history where medium and long-term interest rates are not positively correlated with nominal economic growth. It is also striking that the yield curve steepens while unconventional monetary policy measures are still in place. In Europe, the ECB continues to purchase 30 billion in public and private debt from the market monthly.
Credit institutions are prepared for this scenario of financial normalization. They are more solid and operate under stricter regulation, which is reflected in improved risk management. Their activity is based on three main pillars. The fundamental pillar is providing the best possible financing, which is essential for generating growth and wealth. In Europe, bank financing accounts for more than 70% of the total financing of the economy, although it has recently lost importance due to the strong growth of wholesale financing for large companies. Banks offer financial services to their clients under increasing competition from non-bank entities. It is important that the same regulation to which banks are subject—to protect customers and strengthen financial stability—is applied to these competitors. Another pillar of banking activity is the management of their clients’ savings and the offering of different investment alternatives.
The normalization of medium- and long-term interest rates should not be viewed as a financial restriction. A steepening of the yield curve reflects an improvement in economic prospects and is compatible with an improvement in the supply of financing, especially bank loans. Within the gradual nature of the monetary normalization process, it may be necessary to phase out distorting measures, such as the negative interest rate on the deposit facility. The opportunity to do so must be found.
José Luis Martínez Campuzano, AEB Spokesperson
