MNI INTERVIEW: ECB Likely To Keep Hiking Beyond March – Kazaks
The greatest danger for the ECB is too little tightening, not too much, Latvia's central bank chief tells MNI.
The European Central Bank will probably have to hike beyond March, raising key interest rates at a slower pace but for an extended period even as the economy slides into recession, Bank of Latvia Governor Martins Kazaks told MNI, also calling for the ECB to start reducing its stock of bonds in the first quarter of next year.
At present the greatest danger is from too little monetary policy tightening, rather than too much, with inflation only likely to move back in line with the ECB’s 2% target once rates reach restrictive levels, Kazaks said in an interview in Riga.
“We by no means need to take a pause, for instance, at the turn of the year. It does not mean that we need to raise the rate separately in each meeting, but we should continue. And we should be data driven,” said Kazaks, who in September said the ECB could continue to hike past February. (See MNI INTERVIEW: ECB Could Hike Past February – Kazaks)
While it is unclear how much demand would have to be sacrificed in order to tame inflation, Kazaks pointed to the continuation of some elements of Covid-related support programmes and to savings accumulated during the pandemic which have continued to prop up demand.
“There are lots of nonlinearities, lots of moving parts, so I don't think that you can very easily say what is the sacrifice ratio that you will see. But for the euro area, we also are seeing that those demand elements have grown more important, and that is retaining the risk of inflation persistence,” he said. “Monetary policy itself will take time to feed through.”
At the same time, risks of a shallow eurozone recession have grown “significantly” in recent weeks, he said.
“When we go higher, then of course we have to start to value other risks and be somewhat more cautious; to be aware of the risks becoming two-sided,” he said. “But it's not the time yet.”
Simultaneous tightening by central banks around the world is a further complication.
“One also needs to consider whether the U.S. could go into a deeper recession, because the financial system is interdependent,” he said, “If rate hikes are strong enough and big enough they will spill over into other markets. In our case it is a double-edged sword because if the U.S. moves and you don’t follow it affects the exchange rate, which will feed through. But if the U.S. raises rates, that slows the global economy. “
Having already announced its intention to set out the principles behind shrinking its balance sheet in December, Kazaks said it would be appropriate for the ECB to begin cautiously rolling off reinvestments acquired under its Asset Purchase Programme in the first quarter of next year.
“We still need to see what the forecast and the market situation are going to be in December. If TLTRO repayments happen smoothly, and if it reduces the loans outstanding, that will also kickstart some of the balance sheet reduction. But as straightforward balance sheet elements, APP in my view is the place to start. We will see, but I think the first quarter would be quite appropriate.”
Initial moves should be “relatively small”, with close monitoring of quantitative tightening’s effect on financial stability, Kazaks said.
“It should be a flexible tool, where we explain the principles that we adjust as we see necessary for the economy.”