ECB needs ‘resolute’ hike of at least a half-point: Kazaks

Published Mon, Aug 29, 2022 · 07:44 AM

THE European Central Bank needs to act forcefully and raise interest rates by at least a half-point next month to bring inflation back under control, according to Governing Council member Martins Kazaks.

While frontloading hikes is “reasonable” as price gains near 10 per cent, the pace at which monetary support is removed must be orderly, Kazaks said in an interview in Jackson Hole.

Discussions can begin on quantitative tightening – or shrinking the ECB’s balance sheet – but action isn’t needed now, he said.

Inflation expectations “are still more or less where they should be,” the Latvian central-bank chief said, calling that “good news.”

But he warned that second-round effects are becoming “more transparent and obvious,” urging a “very strong, resolute and clear-cut” response.

A move of “at least 50 basis points would be appropriate” next month, according to Kazaks.

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August inflation data, due on Wednesday, and new ECB projections will be key in determining how big a hike is warranted.

“The increase needs to be strong and significant, and at the current moment, I would say 50 or 75 basis points,” he said.

Kazaks is the latest official to join an unfolding debate on whether the ECB should follow the Federal Reserve in deploying a three-quarter point rate increase.

Governing Council members Robert Holzmann and Klaas Knot have said such a step should at least be considered, though others say an ever-likelier recession may help to tame price pressures. 

In a separate interview, Finland’s Olli Rehn said it’s “action time” for the ECB, calling for a “significant” hike on Sept 8.

Executive Board member Isabel Schnabel and France’s Francois Villeroy de Galhau urged a determined response to record euro-zone inflation that’s more than four times the 2 per cent goal.

The 25 members of the ECB’s Governing Council have become more resolute in their conviction to do whatever is needed, with the bigger-than-expected half-point move at liftoff in July a prime example, Kazaks said.

He sees rates reaching levels that neither stimulate nor constrain the economy in the first quarter, saying they could be lifted into restrictive territory if needed.

Determined action

In the current, uncertain environment, he cautions against offering forward guidance, making it all the more important to understand how the ECB reacts if something happens.

“What I would very carefully monitor is inflation expectations, headline inflation, but most importantly, core inflation,” Kazaks said.

That includes an awareness that “we shouldn’t rush” to retreat “if core inflation in one quarter, one month comes down.”

The prospect of significantly higher rates raises the question of how the ECB remunerates excess cash that banks park with it in the short term – a stash that currently exceeds 4.4 trillion euros (S$6.15 trillion).

The fear is that banks will get risk-free interest income that may impede monetary policy, while the ECB and the region’s national central banks will make losses of a similar size.

The sooner the issue is addressed “the better,” according to Kazaks, who said potential solutions could include a reverse of the tiering policy the ECB used to partially shield lenders from the effects of negative rates.

A more immediate problem is euro weakness.

Kazaks said he’s “not happy where the exchange rate has moved” because it further fuels inflation, while supply snarls mean European firms can’t fully benefit from cheaper exports.

Inflation should peak this year, he said, “but of course that doesn’t mean that things will get cheap necessarily – slowing inflation doesn’t mean falling prices.”

Further ahead, the ECB must start thinking about how it will reduce the trillions of euros of bonds it bought during recent crises to aid the economy.

“The sooner we discuss it, the better it is, but that doesn’t mean – and this is what I think the market should understand – it doesn’t mean if you discuss it today, we employ tomorrow,” Kazaks said. “The first thing we need to do is get some policy space with interest rates.” BLOOMBERG

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