Options for the ECB to Neutralise the Negative Effects of Its Monetary Policy for the European Energy Transition

The European Central Bank’s (ECB) interest rate hikes are “cutting the branch it is sitting on” by stifling economically important green investments, says Rens van Tilburg, director of the Sustainable Finance Lab. As volatile fossil fuel prices continue to drive inflation, he says the ECB should adopt dual interest rates for green projects or risk exacerbating price instability.

In this paper, van Tilburg outlines the “unintended side effects” of tighter monetary policy which “threatens to slow down the energy transition”, and notes that increasing capital costs have led to a “serious deterioration” in the business case for renewables. He also cites findings from Berenschot, a Dutch consultancy firm, that 54% of Dutch Renewable Energy Association members indicated problems with financing for new green energy in the short term, and 32% have delayed or cancelled planned investments.

Van Tilburg highlights that volatile fossil fuel prices are a “clear threat” to price stability, meaning that addressing fossilflation – inflation driven by continued fossil fuel dependency – is essential to fulfilling the ECB’s core mandate.

Current policies fall short of the action needed to shield the transition from rising rates, according to van Tilburg. For example, efforts to decarbonise the ECB’s corporate bond holdings through tilting reinvestments have stalled, following the decision to discontinue reinvestments under the ECB’s asset purchase programme as of July 2023.

Van Tilburg puts forward two key policies to neutralise the negative impact of rising interest rates: tightening requirements for the greening of both the collateral framework and the corporate bond purchase programme, and dual interest rates for green lending.

The most direct way in which the ECB can stimulate green investment and reduce Europe’s inflationary reliance on volatile fossil fuels is through the interest it charges eurozone banks. A targeted green discount interest rate on refinancing operations could incentivise banks to lend to sectors where inadequate investment contributes to inflationary pressure: clean energy production and energy efficiency renovations.

Existing EU regulations such as the sustainable finance disclosure regulation, the corporate sustainability reporting directive and the EU green taxonomy enable banks to effectively categorise their loan books for such a system.

With regards to tightening requirements of the collateral framework and corporate bond purchase programme, van Tilburg recommends a switch to stock-based tilting in the corporate bond purchases and excluding the most climate harmful assets such as coal and new fossil fuel developments. He also suggests limiting eligibility to firms with Paris-aligned transition plans with science-based absolute targets for all emissions, including scope 3 emissions.