Press release with Greenhouse
Paris, September 21st, 2022 – New Reclaim Finance research shows that the bank cannot deliver on its core mandate of price stability without tackling ‘fossilflation’ head on. Climate change and fossil fuels are now such driving forces of inflation that the European Central Bank (ECB) cannot fulfil its core mandate without playing an active role in the low-carbon transition. Failure to act could lead to historic financial turmoil as climate and fossil fuel shocks intensify, according to new research from Reclaim Finance.
Fossil fuel dependency is at the heart of current European high inflation, with natural gas prices pushing inflation to levels unseen since the early 1980s. This is what ECB board member Isabel Schaber termed ‘fossilflation’ in a speech in March. As such, reducing energy use and increasing the provision of renewable energy are the most obvious way to bring inflation under control.
Yet the ECB, the primary entity tasked with managing inflation in Europe, has failed to enact any measures that would contribute to these goals. Worse, it continues to support fossil fuel firms through asset purchases and its collateral framework, while its only response the inflation crisis – raising interest rates – could restrict the development of capital-intensive renewable energy projects.
Reclaim Finance therefore argues that to fulfil its core mandate, the bank must contribute to Europe’s clean energy transition by doing three things:
1. End support for fossil fuel firms by excluding them from asset purchases and collateral frameworks
The ECB has a carbon bias: In 2020, the high carbon sectors of ‘Manufacturing’, ‘Electricity, gas, steam and air conditioning supply’ and ‘Transportation and storage’ account for 61.8% of the outstanding amount (1) for bonds accepted by the ECB as collateral, despite these sectors contributing less than 21% to euro area employment and just 24% to Gross Value Added. In April 2020 the bank held the bonds from 38 fossil fuels companies, including coal companies and companies involved in new fossil fuel projects.
This bias was likely exacerbated by its Pandemic Emergency Purchase Program (PEPP). From April 2020 to September 2021, the number of bonds from the five European oil and gas majors – Shell, TotalEnergies, OMV, Repsol and Eni – held by the ECB rose by 16.2%.
The bank plans (2) to begin tilting its corporate bond purchases towards issuers with “better climate performance” from October this year. But this will not go far enough. The ECB will not exclude any sector – including fossil fuel developers – from its purchases, while the criteria used to define climate performance will likely have little impact on the volume of assets it buys from such companies. Furthermore, it does not plan to apply this process to its collateral framework.
2. Introduce a preferential “green interest rate” for loans related to energy efficiency renovations and renewable energy
Nothing forces the ECB to have a uniform interest rate policy. Indeed, when responding to the Covid-19 pandemic, the bank established a negative interest rate for banks that reached a certain lending threshold. It could use a similar process to channel interest-free or lower rate loans to building renovation and renewable energy projects. This would unlock massive green funding and help fight energy poverty, climate change and inflation at the same time.
3. Coordinate with the European Investment Bank (EIB) and EU Commission to purchase climate bonds
The EIB and the EU Commission could emit “climate” or “just transition” bonds that would be purchased by the ECB through its asset purchases.
This coordination – which would require a political agreement – could significantly contribute to bridging the EU clean energy funding gap. The unlocked funds could be directed to green loans and existing EU funds and programmes, like the Just Transition Mechanism, the Social Climate Fund or the Recovery and Resilience Facility.
Explaining the ECB’s timidity on climate change
The ECB’s reluctance to act more decisively on climate change and fossil fuels stems from its current interpretation of its price stability mandate, notably tied to a focus on ‘market neutrality’ that bars the use of sector or activity-specific policies, and from its belief in the possibility of ‘greenflation’.
But, in the era of “fossilflation” and heightened climate disruptions, this is no longer tenable.
“To manage price volatility, the ECB must recognize that one sector is the overwhelming cause of that volatility”, said report author Paul Schreiber.
Raising interest rates fights inflation by suppressing demand across the economy. It does little to address the specific drivers of the present crisis – fossil fuel prices – but impacts negatively growth, employment, tax and social security revenues and public debt cost. A more targeted response is necessary, that suppresses demand for high-carbon activity while stimulating the green economy.
Furthermore, the bank seems to overestimate the potential for ‘greenflation’. In March, ECB board member Isabel Schnaber said (3), “As more and more industries switch to low-emission technologies, greenflation can be expected to exert upward pressure on prices of a broad range of products.”
However, it is widely recognized that clean energy is cheap and secure and could significantly reduce energy costs and shield consumers against energy price changes. If a swift rise of demand for critical minerals without increased supply could push renewable energy prices up during a transitory period, Reclaim Finance argues that this effect would be limited compared to the impact of fossil fuel prices. It underlined that solutions exist to ensure the adequate supply of key materials. For example, Europe’s biggest metal producers found (4) that 75 per cent of the region’s clean energy metal requirements could be met through recycling.
The key to avoiding this transitory inflation is early investment in a planned transition. Conversely, as Banque de France governor François Villeroy de Galhau put it (5), “The more the transition is delayed and disorderly, the greater the risks of green inflation”.
Time to act
Some prominent ECB figures have, to some extent, recognised these arguments. Christine Lagarde has mentioned several times that climate should be considered in inflation management. More specifically, in June 2021, Schnabel acknowledged (6) that, “The existence of climate externalities implies that we have to reconsider the notion of market neutrality”, while in March 2022 she noted (7) that, “Greenflation has had much less of an impact on final consumer prices than fossilflation”.
However, these acknowledgements are yet to translate into policy changes and concrete action. Against the backdrop of the worst European drought in 500 years and a mounting cost of living crisis for its citizens, the bank cannot afford to delay action any longer.
Report author Paul Schreiber said: “The ECB cannot keep on supporting the companies driving the climate and inflation crises, nor continue to ignore the EU’s urgent need for transition funding. Failure to act could breach the central bank’s mandate and lead to historic financial turmoil as climate change and fossil fuel supply shocks intensify.”
After raising interest rates on September 8th, ECB President Christine Lagarde said, “I cannot reduce the price of energy. I cannot convince the big players of this world to reduce gas prices. I cannot reform the electricity market. And I am very pleased to see that the European Commission is considering steps to that effect because monetary policy is not going to reduce the price of energy.”
But Schreiber responded, “The ECB cannot reduce the price of energy, but it is not powerless in this situation. It could and should use monetary policy to help lower the impact of gas prices, in particular by setting up a preferential lending facility for loans related to energy efficiency building renovation and renewable energy projects.”