MNI INTERVIEW: Need Strong ECB Hikes For Early CPI Win -Kazaks

The European Central Bank probably needs another two sizeable rate increases in the first quarter and then additional smaller hikes before considering a pause in tightening as it should aim to bring inflation closer to its 2% goal well before the end of a three-year time horizon, ECB Governing Council policymaker Martins Kazaks told MNI in an exclusive interview.

“From the current standpoint, February and also most likely March will still require very sizable rate increases,” the Governor of the Latvian central bank said.

While Governing Council decisions would depend on unfolding economic data, failing to deal with inflation now and having to revisit it at a future date would be a mistake, Kazaks said, insisting that further significant tightening was still necessary.

TWO-YEAR HORIZON

He was concerned that working to too long a timeline to bring inflation back to target risked embedding inflation expectations that would be counterproductive. “(Inflation seen close to target by) the end of 2024 or early 2025 is more appropriate, rather than at the end of 2025,” he said. “If inflation remains high for extended periods of time, then nonlinearities meaning possible shifts from low to high inflation regimes, de-anchoring of expectations, are increasing risks, and we should not allow for those risks to materialize.”

Market pricing for the rate cycle peak rose to around 3.3% following last week’s hawkish signalling by the ECB Governing Council, and in particular its President Christine Lagarde, a tightening of financial conditions which Kazaks described as “very welcome,” although he said high levels of uncertainty meant it was too early to say where rates will ultimately settle. (ECB WATCH: Rates Reprice As Lagarde Promises More 50BP Hikes)

With the ECB slowing down the pace of hikes to 50 basis points despite Eurosystem staff projections showing inflation still at 2.3% by the end of 2025, Kazaks commented that: “Rates have moved up and it is an appropriate move. Where they will end during this cycle, I think nobody knows. We'll decide from meeting to meeting.”

“Seventy-five is really a jumbo hike - a series of 50s is good enough to me,” he continued. “There is no need to pause or pivot any time soon, ie. significant rate hikes must continue well into the next year. Yet, at some point the size of the rate hike may need to become smaller allowing us to find an appropriate level.”

REINVESTMENTS

Last Thursday’s decision to slow the pace of asset purchase programme reinvestments by an average of EUR15 billion per month over the second quarter of next year was an appropriate, measured, “well-timed, nicely-placed choice,” said Kazaks, though he added that it was too soon to determine the optimal size of the ECB’s balance sheet,.

“The numbers are not that big, and I would expect that we will gear up those numbers in the third quarter. It's a compliment to, not a substitute for rate increases. But at some point, of course, it will have a more sizeable impact than currently, when excess liquidity is still very high. Gradually, liquidity will be drained and then it will have more impact through the assets part of the other instruments,” he said.