1st Feb 2023


ECB rate-setting versus green climate goals

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Following the European Central Bank's unanimous 9 June decision to end negative interest rates by September, nervous private investors and speculators immediately started selling their government bonds.

This caused average interest rates on government bonds in the EU to spike last week, reaching an eight-year high.

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And because investors fled euro-denominated assets, the euro fell against the dollar, increasing the relative cost of oil (which is traded in dollars), pushing inflation further up.

Conservative rate-setters had pushed hard for this as a tool to dampen inflation in Europe, which hit 8.1 percent in May. But speaking anonymously, one disgruntled council member slammed the decision, telling the Financial Times that "everybody lost."

The average 10-year bond yield is up to levels not seen since 2014 (Photo: ECB)

Less then a week later, on Wednesday (15 June), the ECB's council had to announce new emergency measures — to deal with the fallout from the decision to raise rates.

Although light on detail, the announcement was widely understood to mean a new bond-buying programme similar in design to the €1.6 trillion pandemic emergency purchase programme (PEPP) launched to steady the market in the early days of Covid-19 in 2020.

Old wine, new bottles

Announcing a new bond-buying scheme — just a week after ECB president Christine Lagarde said all bond-buying would end — required some explaining.

And in a speech at the Sorbonne University later that evening (Wednesday 15 June) chief ECB economist Isabel Schnabel told a group of this year's master's graduates that the underlying problem is the EU's incomplete fiscal integration.

As long as there is no permanent EU "risk-sharing" tool and no "euro area safe assets" (EU joint borrowing) the EU will remain unstable.

So when the ECB announced it was stepping down as final backstop to the eurozone, at a moment of overlapping geopolitical crises, markets were brought to the brink of panic.

"I understand why they [the ECB] increase interest rates," economist Rens van Tilburg said. "They had to do something. Inflation was very high, and people expected them to act. But it is very risky."

The interest rate (or yield) rise of 10-year German bonds over the last six months has been the largest this century. Borrowing costs in Italy and Greece have tripled since February, raising the spectre of a repeat of the 2011 eurozone crisis.

The last time the ECB raised interest rates, in 2007 and 2011, a recession followed, the latter spiralling into a full-blown European debt crisis. Highly-indebted member countries — notably Italy and Greece — had to pay double-digit rates on government loans, which nearly collapsed the union.

A total collapse was only prevented when the ECB's unleashed its Outright Monetary Transactions (OMT) bond-buying programme.

Now the ECB has had to reassure investors that it will step in if countries defaulted.

"Fragmentation risk is a serious threat to our price stability mandate. Doubting our commitment would be a serious mistake," Lagarde said on Friday, but she gave little detail on how the new instrument might work.

Democratic deficit

The ECB's decision to increase the cost of borrowing at the cusp of a recession was confounding to some.

"It's about managing market psychology," van Tilburg said.

But a major policy shift, which could increase unemployment, depress wages and affect the lives of millions of workers, just to manage the market, led some to call out the glaring democratic deficit on display.

"This opaque and messy political process in which the ECB, again and again, allows markets to move to the brink of a panic undermines confidence in the euro and the EU," philosopher and economist Jens van 't Klooster tweeted.

Van 't Klooster, who has published extensively on the Frankfurt-based bank, in previous work has pointed out the bank has the legal basis to address economic challenges more directly.

But the bank is shackled by internal division and disagreements on what the ECB should actually be doing.


Keeping inflation at two percent is the ECB's primary objective, but the bank has other responsibilities.

Under the second mandate of the EU treaty, the bank is also obligated to "support the general economic policies in the Union" — which are vaguely defined as promoting social justice, economic growth, full employment and quality of the environment, and it has to prevent "fragmentation" of the union.

Formalised in the 2021 strategy, the ECB intends to include climate change in its policy operations and prevent periphery countries like Italy from having to pay much higher borrowing and debt servicing costs than core countries like Germany (the so-called 'fragmentation').

It already has the tools to achieve these goals.

In a widely-cited paper, van 't Klooster argues that the bank's treaty actually allows the bank to revise and make more explicit what it wants to achieve with its monetary policy.

Likewise, van Tilburg, in his research paper Legally Green has set out why the EU treaty actually obliges the ECB to support governments in their efforts to curb climate change.

Not only under this obligation, but for the ECB to also manage the risks on its own balance sheet and — most importantly — because climate change itself is a threat to price stability.

New tools

To achieve this the ECB could offer commercial banks a discount for green lending, so-called "green-targeted longer-term refinancing operations" (Green-TLTRO's), a concept initially proposed by van 't Klooster and van Tilburg in a joint paper.

Likewise, it can wield its existing pandemic asset-buying programmes like PEPP to backstop weaker EU members and finance green investments.

The bank's senior management, including Lagarde, Schnabel and executive board member Frank Elderson, have publicly supported such measures, including Green TLTROs, and want to modernise the ECB.

But the bank's more conservative members are attached to a notion called "market neutrality."

As long as governments do not meddle in central bank affairs, and central bankers do not intervene in the markets, finance will flow where it is needed most.

Van 't Klooster has told EUobserver previously that market neutrality "just means buying more Shell bonds."

Research has shown conservative members have blocked measures that would allow the ECB to actively target financial flows toward green investments. Instead, they pushed for a return to a situation where interest rates are higher and its asset-purchasing programmes have ceased.

Take it to court?

"These conservative bankers have decided that price stability takes precedence because they prefer not to have to think about climate implications," van Tilburg said. "They cherry-pick what part of their mandate they want to prioritise."

While the decision to raise interest rates decision may eventually help push inflation down, its singular focus on price stability at the expense of other considerations has also threatened the union's stability.

And higher borrowing will "increase the cost of the energy transition," van Tilburg said, potentially causing some member states to delay or scale down their green strategies. Thus increasing the negative impact climate change will have on price stability in the near future.

Central bankers could easily break this dangerous dynamic by defining their priorities more clearly.

Van 't Klooster argued this could easily be done because the EU treaty allows the ECB's council to re-interpret its mandate.

But bankers would need to agree, which could prove difficult.

However, continued neglect of the bank's climate and social responsibility as defined under its second mandate and formalised in its 2021 strategy, could in fact "be illegal" van 't Klooster has argued in the past.

Van Tilburg offered a similar sentiment.

"If someone would raise the issue at the European Court of Justice, the case might look pretty solid," he said.


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