MNI INTERVIEW: ECB Could Hike Past February - Kazaks

The European Central Bank may have to continue raising interest rates beyond February, longer than indicated by President Christine Lagarde, in order to bring inflation back to its 2% target, Bank of Latvia Governor Martins Kazaks told MNI.

While Lagarde told last week’s post-meeting news conference that the ECB would probably raise rates two or three times more, which would mean the final increase could come in February, Kazaks said further hikes may be needed.

“President Lagarde said that, from the current standpoint, we will increase rates over the next several meetings. But it does not mean that by the turn of the year or early next year we are done. If necessary we will go further,” he said in an interview, in which he also said that there was no hurry to commence quantitative tightening.

“There are risks on the downside to growth and on the upside for inflation, and the risk of recession is quite strong, but by no means are we forecasting that recession is going to be strong enough to deal with inflation.”

The Governing Council’s meeting next month is likely to focus on whether to repeat this month’s unanimously-approved 75-bp hike or to reduce the rate of increases to 50 bps, Kazaks said.

“Inflation is high and has been high for quite a while, and our recent forecast shows that it will not retreat that quickly at all. The risks of second-round effects are there, upside risks to inflation are there, and monetary policy still is accommodative. In this environment, removing accommodation is absolutely the right choice.”

BIGGER STEPS

As it is raising rates from very low levels, the ECB can afford to make bigger steps before policy becomes restrictive, Kazaks said.

“When we come closer to that element, of course, then the risks become more two-sided and we may need to be more cautious. But we are not there yet,” he said, emphasising that the ECB must not risk risk second-round effects or any excessive growth in inflation expectations.

“We are seeing the situation much more clearly than it was some time ago. We simply very clearly say that inflation is the problem. We understand our mandate, which is that it is equally undesirable to be above or below 2%. Decisions are relatively straightforward.”

But, even as the ECB raises rates, there is no need for it to rush into running off its balance sheet, said Kazaks. The ECB currently says it will continue to apply flexibility in reinvesting redemptions under its pandemic emergency purchase programme, in order to support monetary transmission.

“Us discussing [QT] does not mean that we are instantaneously switching this instrument on,” said Kazaks. “We simply need to be ready for when we do need to trigger it. One key element [in that decision] is the slope of the yield curve.”

The ECB also decided last week to temporarily suspend the two-tier system for remunerating reserves held at the central bank. However, a similar two-tier system, with remuneration levels linked to banks’ use of funds from the ECB’s Targeted Longer Term Refinancing Operations, could be considered in future as rates rise, Kazaks said.

“This is worth discussing," he said. "We didn’t see it as urgent as the current juncture, but we will discuss it as one in a range of elements.”