MNI INTERVIEW: Beware Temporary Inflation Dip- ECB's Kazaks

The European Central Bank has to be careful not to cut rates too early in response to what may be a brief convergence of inflation towards its 2% medium-term target, Bank of Latvia governor Martins Kazaks told MNI on Thursday.

“The key is that we do not want to hit 2% temporarily and then forget that our target is 2% symmetric over the medium term,” Kazaks said. “We’ve been above our target for quite a while, so I would not be happy to see the medium term pushed into the future. At the same time, it is naive to expect that inflation will just nicely slide down to 2%. There is going to be some volatility.” (See MNI SOURCES: "Biggest Minority" Favours ECB June Cut)

Euro area average headline inflation came in at 2.8% in January compared with 2.9% in December, according to flash estimates. Core inflation was down 0.1 percentage point over the same period, to 3.3%.

“We’ve seen a nice easing of inflation, but we are not confidently at 2% yet,” Kazaks said, adding that the resilience of the eurozone economy, which seems to be avoiding outright recession, is a key factor in the pace of easing.

“If temporarily inflation seems to be below 2%, and then comes back again, I don't think that's a trigger, necessarily, to loosen our monetary policy,” he said. “But if we are persistently undershooting our target, then, of course, that asks for rates to come down.” (See MNI SOURCES: ECB Needs Sub-3% Core Inflation To Consider Cuts)

NO SINGLE PATH TO 2%

Nor should the ECB be tied to any predetermined rate path once cuts begin, he added.

“There is no one, unique path to 2% with the current monetary policy. You could start [cutting] earlier, doing more steps, or you could start it later with bigger steps. All possibilities need to be considered, depending on the incoming data,” he said.

Most of the effect of monetary tightening has now been transmitted into the market, Kazaks said.

“In terms of the strength of transmission, sometimes it has perhaps even been faster and stronger than expected.”

But labour markets remain the “big unknown,” with the extent of spillovers from past and future pay hikes on inflation still to be determined.

While slightly higher vacancy rates point to some labour market softening, “there is still some way to go, and I would urge against a rushed response,” Kazaks said. Instead, “caution and patience” are required, with Governing Council members assessing a variety of leading and actual data indicators.

“There is also a possibility that even though inflation continues to fall, companies do not adjust their price-setting behaviour accordingly, which is related to the issue of unit labour costs. Again, we will have to see the data.”