There were some media stories over the past few days with selected quotes from an interview Patrick Honohan gave to Bloomberg. Dara Doyle from Bloomberg kindly sent me the full text of the interview and since it doesn’t seem to be elsewhere (or at least anywhere I could find) and contains a lot of interesting material, I’m posting it below the fold.
By Simone Meier
May 31 (Bloomberg) — European Central Bank council member Patrick Honohan comments on the banks decision to buy corporate and private bonds, the euro regions economic recovery and Irish banks.
Honohan, who is also head of Ireland’s central bank, spoke in a Bloomberg News interview at his office in Dublin on May 28.
On the ECB’s bond-purchase program:
There are three essential elements in the suite of policies that were adopted on that weekend. The first was a firm commitment on additional fiscal adjustment for some countries that needed it. At that point three weeks ago, the Greek program was already defined but there was a perception that some other countries needed to do more.
Second, that fiscal adjustment needed to be backed up with an undertaking by other member states to make financing available if needed to give time for those adjustments to work through.
In addition to that, since it takes time for the fiscal mechanism to come into place, the challenge of dysfunctional markets needed to be dealt with. That’s where the third element, the ECB’s action, comes in. The short-term markets in some countries might have been reflecting the expectations of market participants, but they were certainly not functioning in a normal way. And this blockage was certainly presenting an obstacle to the achievement of the monetary conditions that the ECB wishes to transmit throughout the euro area.
The decision to buy government paper, or any paper that complies with sound risk-management structures, was exactly the right kind of prompt initiative that was needed. It is unusual in the sense that it was not in the normal course of the ECBs traditional approach to a toolbox but it’s not outside the range of the toolbox of standard central banking around the world or in history. There’s nothing really exceptional about it.
I don’t dispute that it’s an important decision but I think it has been absolutely the right measure at this time. Its evolution has to be carefully managed. Its only part of the three-way attack on the current situation. It’s an ongoing situation, there’s no room for complacency. A lot of things need to be done on the fiscal side on delivering the goods.
On whether he’s happy with the impact of the bond program:
Absolutely. It’s been operated in a very professional and effective way. The markets are convinced that it’s not in any way disproportionate.
On whether the ECB started buying private-sector debt:
I don’t comment on operational matters like that.
On whether there’s a timeframe for the program:
No. We meet twice a month at the level of the governing council. This is a monetary policy instrument. Even so we can consider it on an ongoing basis. You can be assured that were talking about progress.
On whether he shares views of the program posing risks:
Well, let me be absolutely clear. Of course any novel program will involve risks, but I’m solidly behind the program and I think the risks need to be and are being managed. I don’t have any difficulties at all with the program. I’m solidly behind it.
On sterilizing the bond purchases through weekly deposits:
It is envisaged that the bonds will be held until maturity but that’s not a cant ever sell them statement. It’s a hold until maturity statement. The deposit facility is the method used at present to sterilize and its working well, it’s a good mechanism that’s well oiled and there’s been no difficulty with it. To some extent, you might think that it was unnecessary to have a sterilization program when with another window you’re offering full allotment but I think it’s quite important to keep these things in different boxes.
This new box contains an intervention in a particular market to restore its functioning. It’s not intended to alter the overall average liquidity situation in the euro area and therefore it should be sterilized. That means if there are any changes in the overall policy stance, you don’t then have to take separate account of the bond-purchase program because you’ve already sterilized it. It’s a very effective way of ensuring that it doesn’t leak over and have an impact on overall average liquidity conditions.
On whether there was a consideration of re-introducing 12-month tenders of unlimited cash:
No. Nothing is ruled out, but the program of restoration of some measures that had just recently been discontinued is considered to be sufficient for the moment.
On a normalization of Eonia rates:
You mean the relationship between Eonia and the refinancing rate, the gap which is still so high. It seems only a few weeks ago that we were talking very much about a trend and how quickly there would be a trend back to that convergence. But I don’t see any structural change. When the appropriate time comes, and as the exceptional measures once again prove to be unnecessary, I think that the expectations that were there haven’t altered, it’s just sort of on hold, delayed.
On expectations that the ECB will start increasing its main lending rate next year instead of 2010:
For sure, the events over the last couple of weeks have not brought forward the next increase. It’s not surprising that markets would react in this way and I suppose without necessarily endorsing exactly what the market is assuming, one has to be realistic.
On concerns of buying government debt:
You have an exceptional set of circumstances. I think what people are concerned about is any kind of suggestion that a central bank should become a financier of the government and that’s not the intention of this particular tool. It’s not buying debt from the state. Of course it buys from the secondary market, which does alter market conditions for the state. But that’s an incidental effect. Some commentators have expressed concern that by somehow widening the toolbox one is somehow envisaging a monetary financing. But this is very far from the thinking of the ECB.
On widening the range of tools to counter a crisis:
I think we’ve got a wide range of tools at present and this has been an important extension, a use of tools that haven’t been used before. I wouldn’t see any immediate need to reach for more tools. I think were using the necessary tools. I don’t see the need for additional ones. We have what we need.
On the ECB governing council debate on the program:
What strikes me about our discussions is that governing council members actually have a depth of vision that is not reflected in the pigeon holing of some commentators. The argument is at an intellectual level and not an unimaginative reiteration of a fixed orientation. Our discussions on points of substance can be really interesting. I find myself conjecturing how a colleague is going to address a particular issue and often reacting with oh, that’s not what I thought he was going to say. We have rich, interesting discussions.
On whether the euro region is still safe:
I think it is safe actually. I don’t have any doubt in my mind that the euro and the euro area are permanent features of the landscape and their operation will continue to evolve and adapt. I think there are current pressures on certain markets and certain countries and those pressures have manifested in the functioning of the money market but not in a way that makes any difference to my firm opinion that the euro will continue to have an even growing membership of countries.
On whether he sees a normalization on money markets:
I think it’s too soon to say that they are normalized. There has been a degree of normalization after the ECBs intervention. That’s surely true. And bank liquidity conditions are better than they were three-and-a-half weeks ago. But I would expect the situation to evolve further in the direction of normalization over the next several weeks.
On tighter fiscal rules:
I find the proposal of the European Commission in regard to an ex-ante review of broad budgetary plans a very interesting and promising one, with the potential of going some way towards what might have been a gap in our institutions structures in Europe. That’s not one Id dismiss at all. It might be an element of a new landscape that would allow us to avoid a situation where a small number of countries threaten the overall cohesion of the area.
On the ECB restoring market confidence:
Market expectations on average are right but they can be wrong for a long number of years. For a whole decade in the 1980s, Ireland paid an average interest rate penalty of over 250 basis points because of unfounded fears of steep exchange-rate depreciation. The market expectations were something the government had no intention of doing, namely opting for a soft currency. That was a heavy price to pay in terms of an interest premium.
To some extent, Ireland, and no doubt other countries, is facing a similar situation today. Its paying a high premium for a risk that the government has no intention of allowing, something that is not going to happen. I think that restoring market confidence in the solidity of the government’s finances is absolutely crucial. This is why doomsday discussions are actually beside the point because governments have committed themselves to viable fiscal plans. When markets buy into these plans they’ll realize that they’ve actually been underpricing those bonds some time.
On the euro-region economic recovery:
I will return to the fiscal crisis and the uncertainties about how that’s going to play out in terms of having a positive or a negative short-term impact on economic activity. I’m not perhaps as optimistic as some observers on that there’s going to be a faster than previously expected pickup in the second half because I think that there could be negatives — the heightened risk in the government bond market that could offset the demand impetus from a weaker euro. I’m a little bit more on the gloomy side.
On the ECBs upcoming staff projections:
As far as short term forecasting goes, I tend to rely on the ECB projections and additional material provided by our staff here in Dublin. I base my analysis on that.
For me, short-term forecasting is not the name of the game. More interesting is the focus on the best mechanism for adapting to changing forecasts. The ECB forecasts are updated very frequently. At the moment I am not out of tune with their approach to forecasts.
In terms of monetary policy, it seems to me that the current stance of interest rates can hardly be questioned.
One of the things we’ve got to be aware of is the heightened uncertainty given the changes in financial market conditions. That certainly means we are not as sure as we might have been about the accuracy of the central forecasts. That’s not to imply there is need for a change in the central path, but the heightened volatility widens the fan chart in terms of output and employment. I don’t think it makes a material difference in terms of inflation.
It’s not clear whether the new uncertainty tilts the balance upward or downward. On the one hand, the decline in the external value of the euro might have some short term demand impact. On the other hand, we see an increase in risk aversion, which might work in the opposite direction. I think that’s quite an interesting change in the situation, without any immediate consequence in the stance of monetary policy, but in terms of widening out the range of possibilities that are there for the coming year, or two, in the euro area.
On the euro’s decline:
To be honest, as far as the external value is concerned, it had been unusually high. I’m not mesmerized by short-term movements in the euro exchange rate. I have two thoughts about the euro, one in relation to the euro area as a whole, and one with a more national perspective. For the euro area, recent exchange-rate movements don’t represent a significant upward problem for maintain the stability of price evolution. For the Irish economy, I know that for exporters and those facing competition from abroad, there is a degree of relief. Ireland is exceptionally open to the non-euro area in terms of external trade. So it does matter quite a lot.
As I’ve said a couple of times, sterling had been in particular very weak against euro. Although sterling has been weak against the dollar in recent times, there has been a strengthening of sterling against the euro in the past number of months. This is an important factor for exporters in this weak demand environment.
On whether the euro is in line with fundamentals:
Certainly, for the domestic economy, the relativity against our trading partners is more comfortable.
On the Irish economy:
Were close to the bottom in terms of output. Here at the central bank, we are projecting an upturn in the second half of 2010, quarter on quarter. Whether the worst is over is a different question – the worst can mean different things to different people. We know that employment and unemployment tend to lag the cycle.
On Irish unemployment:
Unemployment in Ireland has stopped growing, but to a large extent that is not because of employment growth, but reflects migration flows and withdrawal of people from the labor market. The latter two factors are probably the major ones that have caused unemployment level to plateau. We are looking at a positive development on the output side, but gradual.
Unemployment is something that will have to be managed very carefully.
This will be an important collective effort as the opportunities arrive.
On banks’ capital, bad loans:
The worst is not over for loans. Loan losses are still going to pile up and our forecasts in this regard are not behind those of other commentators. Indeed, taking those additional future loan losses that are ahead of us has been central to our calculations. We want to make sure the banks put in enough capital now, so that as some of that capital is used up meeting the loans losses, it will still plateau through the worst of the cycle at more than 7 percent equity and 8 percent core tier 1.
Were being very demanding on that.
On state-controlled banks:
The two big banks can achieve the capital targets with no significant further injection of state funds, depending on exactly how much they realize on disposals they are making. For Bank of Ireland, it is unambiguous. They have been able to get a rights issue underwritten and so they are raising the additional capital they need from the market.
There will be a conversion of the states preference shares into equity, but not new cash.
In the case of AIB, a similar story, but not quite as clear cut. It depends on how much they realize on the disposals they are making. It’s not completely clear whether AIB would go the equity market soon. I don’t rule it out.
We’ve made quite aggressive assumption on loans losses.
Of course no one can know if they are fully sufficient. But we have a base case and a stress case which are much more aggressive than what has been done in some other countries.
That’s the two big banks, fixed by the end of the year. I think it’s quite good news.
People may not fully internalize and appreciate that we’ve fixed the banks until they suck it and see. It may be some months before the market fully realizes that this is working out.
Anglo Irish Bank is the other bank. The losses there are much more severe, enough to wipe out its initial accounting capital and implying that the state is injecting substantial funds that will never be recovered. Between Anglo and the smaller institution Irish Nationwide, 25 billion euros has been mentioned and I think that number is broadly right.
One way of thinking about the losses is that the shareholders of the banks have taken about half of the losses incurred by the system and the state has the other half. It’s a huge hit for the state, something that is of the same order of magnitude as last year’s borrowing.
It’s because of the decisive recapitalization under way for the two big banks that I’ve been saying that we are well on the way to reducing the risk for both sides, banks and state.
The banks are floating away from dependence on the state and will be free standing. We’ve put that process in place. They are not going to be dependent on coming back to the state for more money. If people examine in detail what were putting in place and do the sums, they will realize that the state will no longer have the problem of unresolved banks hanging over it. The money being poured into Anglo isn’t finished yet, that’s clear, but we know how much it is going to be. So that cloud over the state’s finances should be dispelled.
On bank losses:
You mentioned an article by Morgan Kelly. For me, there’s no news in the calculations it presents. It’s as if he’s exclaiming oh my goodness, there are a lot of losses here. And yes, there are a lot of losses. But we’ve measured them out, we know what they are. He is right in his perception that it’s a heavy price to pay. It’s a heavy burden. But I’m sure that it’s a manageable burden in terms of the large-scale management of the state’s finances.