(RPT)MNI INTERVIEW: ECB Should Hike By Up To 100Bps

(Repeats story filed earlier on June 16 to make clear that the ECB only intends to raise rates by 25 basis points in July)

The European Central Bank should raise interest rates by up to 100 basis points by September, and increase them above neutral levels if inflation projections exceed the price stability target, the governor of the Central Bank of Latvia told MNI in an interview, adding that the eurozone faced a “non-trivial” risk of deep recession.

“If the inflation outlook would exceed our medium-term target, then the rates should go up more than the equilibrium rate. It is not the case at the moment as our medium-term forecast is largely in line with the medium-term target. Yet uncertainty remains very high,” Martins Kazaks said.

Speaking days after the ECB said it aims to raise the deposit rate by 25 basis points in July, and by a larger increment in September should the inflation outlook persist or deteriorate, Kazaks said that although a first 25-basis-point hike followed by half a point remains the most likely outcome, “nothing is set in stone.”

“I think we will need to raise the rates in July and September by, potentially, 50 basis points,” he said. “But that does not mean one should keep racing upwards by 50 basis points every and each time, it will remain data dependent.”

Asked about a comment in a blog by ECB President Christine Lagarde that the ECB could exit negative rates by the end of the third quarter, Kazaks said "Zero or +25bps is not negative. The president’s blog was flexible enough."

NEAR-TERM GUIDANCE

The Governing Council’s June 9 decision to give forward guidance on its near-term rate-setting is useful for the coming months, Kazaks said, although he reiterated that monetary policy decisions will be taken with a gradualist approach according to the macroeconomic environment at that moment, and not with a view to where interest rates might land in the longer-term.

“The monetary policy statement says we ‘intend’ to raise rates,” he said. “This very clearly shows the way I see us operating going forward: we tell the market what we intend to do. But if the economic situation changes, we can of course adjust our decision, because before each decision it will be discussed. That's why relatively clear guidance over a relatively short period ahead [is appropriate].”

An increase in all three of the ECB’s policy rates in July should be followed by a discussion over whether to maintain the spread between them or to opt for a more asymmetric setting in September, Kazakhs said.

RECESSION RISK

Asked whether he thought the ECB’s most recent projections - which foresee GDP growth at 2.8% in 2022 and then 2.1% in 2023 and 2024 – might be optimistic, Kazaks highlighted both a good first quarter of the year and continued labour market strength. But, with both inflation and uncertainty still high, growth is likely to be “quite weak” in the second half of this year and early 2023, with risks clearly to the downside, he added.

“We have two scenarios,” Kazaks said. “One is the negative scenario, where there is quite a deep recession. And the probability of that is non-trivial.”

Kazaks spoke to MNI just hours before the June 15 meeting of the Governing Council which resulted in a commitment to use Pandemic Emergency Purchase Programme reinvestment to prevent any blow-out in eurozone spreads, and moves to design a new purpose-specific tool.

“We don't target spreads,” Kazaks said. “If fragmentation happens, if spreads move in a disorderly fashion putting at risk monetary policy transmission, then that's one signal that there needs to be an intervention. For monetary policy to be effective across the whole of the area, transmission is important.”

Any such tools will require careful consideration of their legal grounding given previous court challenges to ECB action, said Kazaks. (See MNI SOURCES2:ECB Mulls Crisis Tool As Officials Debate Spreads)

“When we create new tools or employ existing tools, we always think of proportionality,” he said, ”We have a very strong mandate, but of course there are legal issues that need to be taken into account, and we will always do so.”