Introductory remarks by Klaas Knot at the press conference on the FSR

The world around us

• First of all, I would like to reflect on the unprecedented economic situation in which we currently find ourselves. We have not seen the combination of skyrocketing inflation, weakening growth prospects and rising interest rates for some four decades. We are still in the recovery period from a pandemic that has gripped the world for two years. Just when the final lockdown was lifted in the Netherlands and we thought we could catch our breath, Russia invaded Ukraine. The future course of the war is extremely uncertain and is seems the end is by no means in sight.
• The war has indirect but major consequences for our economy. In the first half of this year, the Dutch economy was still growing surprisingly strongly, with increases in consumption, exports and business investment. The labour market also remains tight and producer sentiment is largely positive. Looking ahead, however, the picture is shifting. Concerns are mounting about a global recession, and I share those concerns.
• The economy is currently overshadowed by historically high inflation and rising interest rates. Two-thirds of the current high inflation is still due to rising energy prices, but almost all products are now also getting more expensive. At 6.4%, core inflation, which excludes energy and food prices, is now also well above our target. In response to high inflation, central banks are raising interest rates in large increments and the long period of ever lower interest rates has come to an end.
• Lagging wage growth means that households are losing part of their purchasing power. Although government support measures provide much-needed relief, low and middle income groups in particular are finding it harder to make ends meet. An increasing number of them are also running into financial difficulties. The high energy prices are also affecting businesses that consume a relatively large amount of energy, and come on top of long-standing supply chain disruptions and a tight labour market.

Vulnerabilities

• Moreover, the relatively high levels of household and corporate debt in the Netherlands are a vulnerability. On the one hand, inflation has an immediate positive impact on debt, as the size of fixed debt amounts decreases in relation to the repayment capacity, which is usually expressed as a nominal income amount that increases with inflation. On the other hand, wage growth has thus far lagged behind inflation, clearly inhibiting this mechanism for many households. In addition, higher interest rates pose an acute risk to households and businesses when a fixed-interest period or loan agreement expires and residual debt remains outstanding.
• With regard to public finances, the Netherlands is in a relatively solid position. The high debts of some Southern European member states in particular pose a risk, although rising interest rates will not cause any immediate problems. After all, in times of low interest rates, much government debt is financed on a relatively long term, meaning that rising interest rates only make themselves felt over time. If economic growth slows, however, doubts about debt sustainability may quickly resurface in financial markets, especially if fuelled by accommodative fiscal policy.
• This brings me to those same international financial markets. Rising interest rates have triggered significant falls in prices of risky assets. Equity prices worldwide have lost around a quarter of their value since the beginning of this year. That is substantial. At the same time, financial markets are still assuming that inflation will return to 2% in 2024. However, persistently higher inflation might lead to new price corrections in financial markets.

Resilience

• What does this mean for the Dutch financial institutions?. The increased risks are testing the financial sector once again. The good news is that the Dutch financial sector remains in a strong position, even after the coronavirus crisis. Banks’ buffers are well above the statutory minimum requirements and have passed a robust stress test. Insurers’ solvency is satisfactory and pension funds’ funding ratios have risen substantially this year as a result of the higher interest rates
• The recent and expected developments will not be without consequences, however. Banks must prepare for an increase in credit losses on their outstanding loans, for example because energy-intensive businesses can no longer meet their commitments.

Policy

• To round off, what does all of this mean in policy terms?
• First, in view of the uncertainty and elevated risks, it is important that banks maintain their buffers. We therefore call on banks to exercise restraint with regard to dividend distributions and share buybacks.
• Second, since the beginning of this year banks have been subject to a floor in the risk weighting of mortgage loans on their balance sheets. Due to the persistent systemic risks in the housing market, we have decided to extend that lower limit by two years.
• The signs of a cooling housing market have reached me too. I would stress that some cooling in the overheated market is not undesirable, although in an environment of rising mortgage rates and worsening growth prospects, further price corrections cannot be ruled out. Banks should be able to bear the consequences of exactly this kind of sharper price correction. And that is where this floor for risk weighting comes in.
• Third, and this is not the first time I have said this, the ECB will continue to raise interest rates until there is once again a credible prospect of a return to the stability target of 2% inflation in the medium term. Our task is to ensure that high inflation does not become any more entrenched. To do so, we are hitting the brakes hard.
• But high inflation requires a collective response. It is therefore important that the government does not simultaneously step on the accelerator by letting its deficit widen further. Financial support to vulnerable households is fully understandable and also desirable. But any support should be targeted and temporary in nature, and not funded with uncertain future revenues. After all, inflation is here now.