MNI INTERVIEW:Core Inflation Jump Needed For 50Bp-ECB's Simkus

The European Central Bank should raise interest rates by 25 or 50bp at its May monetary policy meeting, the governor of the Central Bank of Lithuania told MNI in an interview, although he added that a larger-than-expected upwards move in core inflation would be needed to justify another half-point hike.

With core inflation yet to peak, Gediminas Simkus said on the sidelines of the IMF’s Spring meeting in Washington that the case against a pause in the hiking cycle was “clear” even as headline inflation trends downwards.

“I would need to see the data in May before deciding whether it should be 25 or 50bps, but we need to send the message that the ECB remains determined to get inflation back to its target,” he said.

“We have done a lot in a year. We also understand that for past monetary policy decisions to come into effect we also need time. To do 50bp would require some vivid indications, something very clearly beyond current expectations, that it was necessary to do so. But the key thing is not to stop now.” (See MNI INTERVIEW: ECB Peak Rate 3.5-4% Good Starting Point-Wunsch)

RESTRICTIVE TERRITORY

Further hikes could follow, Simkus said, with rates likely to remain in restrictive territory until at least the end of 2023 in response to continued high prices and strong wage growth.

“I don't believe that prices will get back to the levels they have been before because that would mean you have disinflationary processes, and all the projections show inflation, not disinflation. And this will also contribute to wage growth.”

How the ECB continues to shrink its bloated balance sheet could be discussed in a matter of days, Simkus said, with a full stop to reinvestments from the asset purchase programme one option that should be “on the table” for consideration.

But caution and consistency remain guiding principles in managing Pandemic Emergency Purchase Programme reinvestments, currently set to run until at least the end of 2024.

“We need to know that markets are capable of absorbing these additional securities,” he said. “But assuming that is the case, May or June would be an appropriate time to discuss what we do with the balance sheet, and I believe that among the options on the table should be a full reduction of APP reinvestments. But again, any reductions have to run in the background.”

U.S. HARD LANDING FEARS

On Wednesday the IMF warned that the U.S. economy could face a ‘hard landing’ if the Federal Reserve continues to raise interest rates, which would be another factor for ECB decision-making.

“It’s less about whether the U.S. economy itself has a hard landing, and more about how a hard landing in the U.S. could affect the European economy, European inflationary processes and dynamics,” Simkus said, “That is what I would look at - not at particular developments in other jurisdictions.”

Recent banking crises in the U.S. and Switzerland highlighted the strength of EU regulations and institutions, he said.

Moreover, the fact that “the growth of interest rates should imply positive results for a typical bank,” was a factor in the Lithuanian government’s recent decision to introduce a solidarity or windfall tax on local banks’ profits from net interest income, he said.

“In beginning of April, Lithuanian Government approved the draft law for the introduction of a temporary solidarity contribution on banks. It would be applied to the profits of banks, which were at record levels last year and will only increase as interest rates increase.

“It will be interesting to see whether such a move, which could be repeated in Estonia and Latvia, may also be adopted by other EU member states."