MNI INTERVIEW: Market's ECB Outlook Too Rosy- Berlin Advisor

The European Central Bank could raise rates further than financial markets are pricing as current assumptions seem overly optimistic, a leading German economic advisor told MNI in an interview.

Klaus Adam, an advisor to the German Finance Ministry who spent almost five years as an ECB researcher up to 2008, said a nominal interest rate of 1.5% -- roughly in line with market pricing for summer 2023 – looks to be too low to bring inflation back down to the Bank’s target of 2% over the medium term.

“That is really a Goldilocks scenario, in which, basically, the problem solves itself, largely because we never have to raise real interest rates above zero, ever,” he said.

“That is what is implied by the inflation projection,” Adam continued. “That strikes me as very optimistic. It’s not impossible, but it assumes you never have to move the real rate above the long-run neutral rate.”

PEPP CONCERNS

Adam -- a member of the Finance Ministry’s Academic Advisory Board – also expressed concern that continued ECB purchases of Italian and Spanish government debt using reinvestments from its Pandemic Emergency Purchase Programme were unnecessary and would embolden political extremists.

“I have a hard time understanding why the current spread levels are anything that would be out of line with fundamental pricing,” he noted. “It was also not something that was ever getting close to Italy losing market access.”

The ECB’s “safety net” allows countries like Italy to elect whatever government they want “because they are well-protected,” Adam said. (See MNI INTERVIEW: TPI A Panic Move ECB Will Lament - Kraemer)

“These are the consequences of this sort of policy -- and once you start, it's very difficult to stop,” he warned.