MNI INTERVIEW: US Soft Landing Key To ECB Easing

The European Central Bank could cut interest rates sooner than it had expected unless a U.S. soft landing delays monetary easing, an advisor to the German central bank told MNI,

A decline in service price inflation from 4.6% in October to 4.0% in November indicates core prices may not prove as sticky as feared, as the ECB makes “promising” progress towards its 2% medium-term inflation target, Bundesbank research professor Klaus Adam said in an interview.

“Everything is going in the direction they want, actually even a little better than they anticipated,” he said, calling the decrease in services inflation very encouraging news, “This puts further interest rate increases off the table, and in fact might bring interest rate cuts quite a bit forward in time.”

But upward pressure on the neutral rate of interest will come from fiscal spending - with a lot of debt expected to come on the market in coming months as the U.S. government in particularly runs a large deficit at a time of full employment - as well as investment demand coming from the green transition, said Adam, also professor of economics at the University of Mannheim and a member of the Advisory Board to the Federal Ministry of Finance.

“I could not easily see a situation in which capital markets are willing to absorb these quantities without requiring higher real rates, and indeed real rates have gone up in the U.S. and worldwide,” Adam said. “The timing of cuts also depends on whether we're going to get a soft landing in the U.S. If we have that, then maybe rates need to stay higher a little longer. If we don't have it, then maybe we need to cut earlier.” (See MNI SOURCES: ECB Needs Sub-3% Core Inflation To Consider Cuts)

OPERATIONAL REVIEW

On the subject of the ECB’s operational strategy review - the results of which are due in spring 2024 - Adam said major changes were unlikely.

“It would be wise to stay with the floor system, and to have the flexibility to provide or withdraw excess liquidity as needed. That's probably the likely outcome of this review. A corridor system is much more complicated,” he said. “By and large, the size of the balance sheet is going to regulate itself over time, just because in a nominally growing economy, the relative size of those purchases is going to melt down by a rate relative to nominal GDP every year. As long as that's happening it is not something to be particularly concerned about.”