Interview with Christine Lagarde, President of the ECB, conducted by Theano Theiopoulou and published on March 27, 2022

March 26, 2022

Do you think the European response to Russia’s invasion of Ukraine is strong enough?

Let me first express my deep sadness for the continued loss of so many lives as a result of the Russian war against Ukraine. The decisions of EU governments clearly demonstrate their determination to respond to this horrific act of aggression and their solidarity with the Ukrainian people. It is crucial that the sanctions are effectively implemented, and the ECB is doing its part. Although we do not have a mandate to assess and enforce banks’ compliance with the various sanctions regimes, we work with relevant European and national authorities to ensure that banks know how to apply sanctions.

When we were on the verge of leaving the pandemic behind us, we are now facing a new crisis because of war. To what extent can this harm or delay the economic recovery that was underway globally and what is the risk of having a recession in the euro zone if the war is prolonged?

The war is expected to have a huge impact on the global economy, and in particular on the European economy due to Europe’s proximity to Russia and its dependence on Russian gas and oil. This will likely slow Eurozone growth and push up inflation in the near term through higher energy and commodity prices, confidence effects and disruption of international trade. Of course, the overall impact will very much depend on how long the war lasts.

Our baseline projections, which include an initial assessment of the impact of the war, do not foresee a recession, given the buoyancy of the eurozone labor market and the end of the pandemic. Projections call for the economy to grow by 3.7% this year and 2.8% in 2023. However, given the significant uncertainty, ECB staff have prepared two alternative scenarios: an adverse scenario and a harsh scenario. In the severe scenario, growth could be as low as 2.3% in 2022. But there is a lot of uncertainty around these estimates.

Is there a risk of stagflation? Could the euro zone economy stagnate?

So far, incoming data does not indicate a significant risk of stagflation. The euro zone has returned to its pre-crisis level of production, growth continues and the labor market remains solid. In the short term, the surge in inflation is driven by pandemic-related factors, fueled more recently by the war-related global energy price disruptions.

Prior to the invasion of Ukraine, many member states increasingly called for raising interest rates and tightening monetary policy to control inflation. Do you think developments in Ukraine will mean a postponement of such decisions or are higher rates still possible in 2022?

As you know, our decisions and the path to policy standardization are entirely data driven. Our forward guidance is very clear on the conditions we must observe before considering raising interest rates.

Under current conditions, more than ever, we need optionality in our monetary policy. This is clearly reflected in our latest policy decisions in March. We have revised the trajectory of net asset purchases and will gradually reduce them in the second quarter of this year. We have indicated that if the incoming data confirms the expectation that the medium-term inflation outlook will not weaken even after the net asset purchases end, we will conclude the net asset purchases in the third quarter. If, on the other hand, the outlook changes and funding conditions deteriorate in a manner inconsistent with our 2% inflation target, we are prepared to revise our schedule of net asset purchases in terms of size and /or duration.

We remain very attentive to the prevailing uncertainties. The calibration of our policies will continue to be data driven and will reflect changes in our assessment of the outlook. We will take all necessary measures to fulfill our mandate of pursuing price stability and safeguarding financial stability.

How real is the risk that the ECB’s worst-case scenario of 7.1% inflation in 2022 materializes?

This is not the baseline scenario in the ECB staff projections. It is also important to highlight that in all of our scenarios, inflation is expected to decline and stabilize at levels close to our 2% target in 2024.

Was it possible for the ECB to foresee the huge problem of very high energy prices even before Russia invaded Ukraine?

Rising energy prices are primarily the result of geopolitical tensions, and you cannot easily predict the impact of such tensions. We try to take into account the high uncertainty linked to the current situation, which is why our latest projections have been accompanied by the most negative scenarios. Energy prices were also affected by unusual weather conditions, which were also impossible to predict.

Is it possible to reduce the EU’s dependence on gas, oil and other Russian raw materials in the next few years?

Many European governments are working hard to reduce their dependence on Russian energy, but it takes time. Russia accounts for 22% of euro area energy imports. These cannot be replaced overnight. The euro zone is also heavily dependent on other Russian raw materials, such as nickel, cobalt and vanadium. Economic dependence on hostile actors is indeed a vulnerability.

Cyprus is heavily dependent on Russian tourism and Russian business. How serious do you think the impact of the war on the Cypriot economy will be?

The war will affect the Cypriot economy through a number of channels. Arrivals from Russia and Ukraine accounted for up to 25% of the total, so authorities’ initiatives to substitute and diversify sources of tourism are the right approach. Furthermore, given the importance of Cyprus as a hub for foreign direct investment to and from Russia, professional services such as accounting, consulting and legal services are also expected to be affected. Finally, the Cypriot economy will be affected by inflationary pressures due to rising energy costs due to its dependence on oil imports for electricity generation.

However, you know very well that every challenge can also be an opportunity. Cyprus is the easternmost and southernmost member of the EU. It offers a European institutional framework, the security of the euro as a currency, and can serve as a hub for business in the Middle East and North Africa region. Your country has demonstrated time and time again that it is nimble and can face challenges and emerge stronger.

After the 2013 crisis, the Cypriot banking system significantly reduced deposits of Russian funds and exposure to the Russian market. How do you rate the way he handles the turbulence caused by the war? Has the impact of sanctions on banks been greater in other euro-zone countries?

Direct exposures of the Cypriot banking sector to the Russian economy are overall rather limited and continue to decline. Profitability loss from card transactions or wire transfer fees related to Russian customers is also limited. The indirect effects of tourism are significant but can be mitigated by efforts to diversify tourism sources.

Let me also note that significant progress has been made in recent years in stabilizing the banking system, improving solvency and liquidity positions and reducing the stock of assets inherited from the past. The Cypriot banking system is now better prepared to withstand the current crisis. The last time I was in your beautiful country, ten years ago, things were going to be extremely difficult. But Cyprus today finds itself in a totally different position, having successfully resolved many of the problems it has encountered in the past.

On Thursday, RCB Bank announced that it was ceasing operations and refunding all deposits. Your comment on this?

This was a business decision and I will not comment on individual institutions in accordance with our standard policy at the ECB. What is important is that all deposits will be refunded. In a sense, this decision removes some of the uncertainty and should boost confidence in the Cypriot banking sector in the medium term.