MNI INTERVIEW: September Rate Rise Probably ECB's Last- Simkus

The European Central Bank has probably raised key interest rates for the final time in the cycle, the governor of the Bank of Lithuania told MNI, adding that cuts would be on the table if growth declines more quickly than expected.

“Barring any surprises, I don’t expect for us to need to think about another hike,” Gediminas Simkus, regarded as a monetary policy hawk, said in an interview. “I would say that we are in sufficiently restrictive monetary policy territory. But of course, it will eventually depend on the data.”

With attention shifting to how long rates will remain at their peak, Simkus said that while it is “way too early” to talk about cuts, Governing Council members will also pay close attention to the health of the eurozone economy.

“Our baseline is a soft landing rather than a sharp decline in GDP. But it's quite clear that if the economy proves to be much weaker than projected, and we have to revise the GDP forecast, then we will see,” he said. “We can't ignore the euro area growth output in general, because it very much plays into price pressures in the medium term. I am already trying to think about what’s important for 2026.”

BIG DROP IN INFLATION SOON

Energy prices are a potential source of volatility, but base effects mean a "substantial drop" in inflation can be expected "pretty soon," he added. While wages - a key indicator of future price trends - may not yet have peaked, he saw “some evidence that they have, and that the pace of wage growth may decrease in the near future.”

Inflation expectations are anchored and the chances of second-round effects diminishing, he continued, with weaker demand and the slower passthrough of wages into goods and services offering reason to believe risks to the inflation outlook are “more or less balanced.”

A solid majority of Governing Council members last week backed hiking rates for a tenth successive time, adding 25bp to take the deposit rate to an historic high of 4.50% (See MNI SOURCES: Hawks Aim For ECB Hike Before Data Ties Hands). The decision not to pause came after average inflation was revised upwards for this year and next, settling fractionally above the ECB’s 2% target by 2025.

But September’s ECB staff growth projections were downgraded “significantly” to 0.7% in 2023, 1.0% in 2024 and 1.5% in 2025, with risks tilted to the downside.

PEPP REINVESTMENTS

Simkus said he did not know whether October's meeting will see major differences of opinion, but noted that the publication of the latest Bank Lending Survey will be a useful tool in deciding the ECB’s next steps, with monetary policy currently well transmitted into the economy via financial conditions.

Policymakers did not discuss the future of reinvestments from the ECB’s pandemic emergency purchase programme (PEPP) last week. But it would be better to have a debate about how and when to start gradually winding down ahead of the likely end-2024 cut-off sooner rather than later, Simkus said.

“One of the ways to ensure our commitment to keep the appropriate level of monetary policy tightening is also using tools such as balance sheet policies.

“PEPP is the first line of defense against fragmentation, and you should be very, very careful to safeguard the stability of the financial markets from any negative shocks. At the same time, the end of 2024 is approaching fast and we are going to need a decision. Much has changed since the - correct - decision on PEPP was taken.”