MNI INTERVIEW:Ex ECB's Gerlach Sees Possible Rates/QT Tradeoff

Hawkish European Central Bank policymakers could agree to hike interest rates by 50 basis points on Dec 15 rather than make a third consecutive 75-point increase in return for an earlier-than-anticipated start to running off bonds from the ECB’s balance sheet, former Central Bank of Ireland deputy governor Stefan Gerlach told MNI.

“I see a potential trade-off between interest rate increases and” quantitative tightening, Gerlach said in an interview. “I can imagine that there will be pressures to introduce QT already in January, in a very limited way, in exchange for 50 basis points. That could be a possible outcome. It could be, say, 90% [of current Asset Purchase Programme reinvestments] for the first few months, and then greater reductions later in the spring.”

Policymakers have already indicated a 50bp hike is on the table in December. (See MNI INTERVIEW: ECB To Consider Smaller December Hike - Lane) The ECB might also consider raising rates by a further 25bps in February in order to avoid having to hike into a recession later, said Gerlach, who spent four years at the Central Bank of Ireland until 2015 and is currently chief economist at EFG Bank, Zurich.

Continued uncertainty surrounding the war in Ukraine means the anticipated eurozone downturn “is not necessarily going to be a temporary, shallow recession,” he said, adding that inflation could also fall quickly.

INFLATION NEAR PEAK

“Inflation will peak sometime soon in the euro area, and it may even be peaking now,” he said. “If you look at the U.S., headline inflation is coming down. In Switzerland it’s coming down. Given what has happened to energy prices, there is the potential for a big drop in inflation going forward.”

Profit margins rose in some European countries as Covid reopenings fuelled demand, giving companies more margin to absorb wage growth without further increasing prices, he noted.

As rates rise, the ECB may yet follow the September decision by the Swiss National Bank to tier remuneration on reserves held at the central bank, said Gerlach, noting that “the politics of paying out billions in interest to banks is always difficult.”

The SNB is also tightening, and is likely to hike its policy rate by 50bps to 1% next month, and signal that it will continue to allow currency appreciation to curb imported inflation.

"The SNB stated in December 2021 that it had allowed the Swiss franc to appreciate in nominal terms to counter inflationary pressures coming from abroad in the second half of 2020,” Gerlach said. “What has since become clear - as confirmed by Andrea Maechler in a speech she gave last week - is that this was far from a short-term approach, and in fact became policy from last December onwards."

Next month’s SNB forecasts should show a downward trend for both GDP and inflation. While deep recession is less likely for Switzerland than for the eurozone, headline inflation may take longer to fall due to the high proportion of government-controlled price inputs.

“They will probably do 50bps, although I think 75bps would be better given that inflation in Switzerland is much above target, at about 3%, and it may take some time to come down. Almost a third of the prices in the CPI are administered, and they tend to react with a delay relative to others,” Gerlach said, “The SNB can also start shrinking the balance sheet by selling on foreign assets.”