MNI INTERVIEW: ECB Peak Rate 3.5-4% Good Starting Point-Wunsch

Recent market expectations of a peak European Central Bank deposit rate of between 3.5% and 4% look about right, but inflation could remain slightly above the 2% target for some time, Belgian National Bank Governor Pierre Wunsch told MNI, adding that a U.S. hard landing could also influence eurozone monetary policy.

“Markets’ expectations have been going between 3.5 and 4% over the last four months, and I think that's a good starting point for where we need to go,” Wunsch said in an interview at the International Monetary Fund meeting in Washington.

The ECB hiked the deposit rate by 50 basis points to 3% at its last meeting in March, and overnight index swaps currently imply a peak of about 3.7% by September or October. But this may leave inflation still above the ECB’s target in strict terms, Wunsch conceded. (See MNI EXCLUSIVE: ECB Should Hike As Market Fears Wane - Kazaks)

“I would not exclude that [headline inflation] remains slightly above 2% for a while. If we have another year of inflation at 2.3%, to me it's basically around the target,” he said. “We've learned in the last few years that we cannot truly stabilise inflation at 2% - there is some room for manoeuvre around 2%. What is important is that it cannot remain substantially higher than 2%.” (See MNI ECB WATCH: Rates Up 50Bps With 'Ground To Cover' - Lagarde)

U.S. ECONOMY

A hard landing for the U.S. economy after the Fed’s hiking cycle could become a factor for the ECB, Wunsch said.
“We always try to calibrate a soft landing, but we don't always get to the soft landing. That's part of reality,” he said. “ Of course, if there will be a hard landing in the U.S., we will take that into account in Europe and to that extent it would have an impact on the economy.”
But the ECB should continue to reduce its balance sheet accumulated during quantitative easing, particularly if governments’ fiscal stance remains too expansive he said, arguing that the eurozone had “flirting with a weak form of fiscal dominance” for a while.

“I never had the impression that the fiscal situation had an impact on the decisions we were taking, but now, if we have a recovery, we really need fiscal policy to contribute, for deficits to go down. And we need to recreate buffers, which is also a reason why we need to decrease our balance sheet,” he said.

The years ahead will see “difficult discussions” on moral hazard in the financial sector in case of further bouts of instability following banking problems in the U.S. and Switzerland, he said.

“You don't want states' warranties or intervention as the basic assumption, but at the same time, when it's not fair weather, excluding the possibility of bailouts doesn't really work,” he said. “The only answer is that, at the end of the day, the public sector has to convey trust in the solidity of the sector. And if it implies, or conveys the message, that all deposits can be protected, at least temporarily, you have to do it.”