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The European Central Bank could potentially end asset purchases this year but inflation projections must stabilise at or above 2% over the medium term before any signal for key interest rates to rise, Lithuanian central bank governor Gediminas Simkus told MNI.
“Monetary policy needs to stay accommodative. I see very little probability of us hiking interest rates this year,” Simkus said in an interview, adding that while upside risks for inflation in 2023 and 2024 “potentially are stronger”, official estimates still foresee increases in prices below the 2% target for the period.
For now policymakers should be prepared to look through short-term risks such as surging energy prices and give greater weight to the likely absence of large pay rises, he said, pointing to February’s gathering of the ECB’s Governing Council as a “second calibration meeting” following December’s decisions to end net pandemic bond purchases in March. The separate Asset Purchase Programme will also be boosted to EUR40 billion a month in the second quarter, before falling to EUR20 billion from October, then continuing at that rate for as long as necessary to reinforce the accommodative impact of low rates.
“I don't see any issues or problems with the sequencing - ending APP in 2022, if needed, then moving onto the path of interest rate rises,” Simkus said. “But we need to see inflation returning to 2% levels over the medium term.”
Eurosystem staff macroeconomic projections in March will be key as the ECB charts its course.
“Looking ahead to the March meeting, what's important here is how much the new forecasts are in line with those made in December. We really need to see all the data pointing to the fact that we will arrive at our target,” he said, “Yes, there are upside risks, but we need to see that materialise. We remain open, we remain flexible. If we are approaching our target level of 2% inflation we are ready to act.”
The ECB feels no pressure to accelerate its own tightening cycle in response to recent moves by the Federal Reserve and the Bank of England, according to Simkus.
“What's important for me is that inflation is going down throughout 2022, and that it stabilises at levels that are close but still below 2% in 2023 and 2024.”
Wage growth will be crucial in determining inflation’s longer-term trajectory, Simkus said, though he cautioned that the end of the pandemic may lead to a return to trends which have kept pay down in recent years, such as the growth of the gig economy.
“This may lead to decreasing labour market power, which in turn means that it's harder and harder to achieve our inflation aim because negotiated wages do not reflect productivity growth plus the inflation rate. This might be the reason the euro area has struggled to reach 2% inflation.”
NEW VARIANTS BIGGEST THREAT
New structural inflationary pressures may be emerging as well, he acknowledged, speaking after Executive Board Member Isabel Schnabel said the transition to a green economy might drive prices higher.
“It's quite obvious that the green transition comes with some costs, whether it is energy prices, carbon-intensive energy prices, and also in general price inflation,” he said. “These are the parameters that need to be introduced into and monitored when making monetary policy decisions, because the effect is not immediate.”
The biggest threat to the eurozone economy would be the emergence of further Covid variants, leading to the reintroduction of containment measures, Simkus said.
The ECB’s promise to manage the reinvestment of bonds acquired under its Pandemic Emergency Purchase Programme to monetary policy needs would provide a manner of responding in such a contingency, he added.
“This is the key when we refer to PEPP reinvestment or even the kind of renewal of net purchases under the PEPP,” he said. “It's very much related to how the pandemic situation affects this particular case and how the financial markets react. That's the elephant in the room.”
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