ECB’s Stournaras: QT Has Potential to Cause ‘Severe Consequences’ for Financial Stability, Economic Prospects

15 November 2022

By David Barwick – FRANKFURT (Econostream) – European Central Bank Governing Council member Yannis Stournaras on Tuesday warned that quantitative tightening could, depending on the degree, have profoundly negative financial stability and economic consequences.

At a roundtable discussion organized by investment banking group AXIA Ventures in Athens, Stournaras, who heads the Bank of Greece, said of QT that the Council would ‘actually discuss the prospects of future steps in this direction’ in December, adding that ‘[a]ny such steps should be cautious and gradual, as quantitative tightening reinforces interest rate increases across the yield curve.’

Stournaras cited a Bank of Greece working paper from which could be inferred that ‘tightening monetary policy by scaling down central banks’ balance sheets to pre-crisis levels may lead to sharp increases in sovereign bond yields globally and widening spreads of vulnerable sovereigns, with severe consequences for financial stability and the economic prospects.’

The ECB would deploy the Transmission Protection Instrument ‘to the extent needed’, he reminded.

Asked where interest rates might peak, he demurred, noting the elevated uncertainty and the current lack of ‘hard evidence’ concerning an end to Russian military aggression.

‘There are significant risks for price, economic and financial stability’, he continued. ‘Based on current evidence, there is some ground to cover until we see the peak of the interest rate hike. As I said, however, the pace and the ending level of our interest rate path will depend on evolving conditions for inflation and output, which will be assessed in a meeting-by-meeting approach.’

The ‘substantial progress’ of the ECB in normalising policy has set it on a path to achieving its price stability goal, he said.

‘I would avoid using technical concepts such as the “neutral” interest rate or the “target-consistent terminal rate (TCTR)”’, he said. ‘The estimates of these interest rates are based on unobservable elements and, therefore, subject to large uncertainty. The concept of neutral rate was briefly discussed at our latest monetary policy meeting and was found “not necessarily helpful”’.

‘Having said that, we will continue to base the pace of our interest rate rises on the evolving outlook for inflation and output, following our meeting-by-meeting approach’, he added.

Thanks to its previous efforts, Greece’s fiscal position is such that ‘the interest rate risk from the increase in current bond yields is rather limited for the public sector’, he said. Still, given the expected medium-term increase in the market rate risk of Greek public debt, it is fortunate that the primary surplus is intended to be 0.7% of GDP next year and be approximately equal to net interest payments thereafter, he said.

Stournaras appeared to confirm that he continues to expect Athens to regain investment grade in the first half of next year, notwithstanding political risk associated with upcoming elections.

‘If Greece surprises positively in (a) fiscal developments in 2022 and (b) GDP growth in 2022, continuing in parallel the implementation of its structural reform programme, I see no reason why incoming national elections could be an obstacle to achieving investment grade’, he said.