By David Barwick – VILNIUS (Econostream) – An interest rate hike next week by the European Central Bank is clearly warranted and will probably have to be followed by further tightening, given the strengthening of inflation pressures in the region and the unexpected resilience of the euro area economy, according to ECB Governing Council member Gediminas Šimkus.

“[A]ll the data currently available lead me to think that it's very likely that we will hike, and that this September hike is not going to be enough,” Šimkus, who heads the Bank of Lithuania, told Econostream in an interview on Monday (transcript here).

“Overall the inflationary environment has strengthened, making the case for a hike pretty clear,” he said. “[T]hat makes it clear, from my perspective, that we should hike in September.”

Šimkus cited a wide range of factors that he expected would lead the upcoming macroeconomic projections to indicate a need for additional monetary tightening in order to achieve the ECB’s price stability target.

“With gas futures prices up, with oil prices mostly at the June levels, with the implications of the war in Ukraine on wheat and grain exports from Russia and Ukraine, with agricultural commodities (wheat, corn) prices generally going up, and with the European economy showing signs of being stronger and more resilient — this should lead to projections that would require the interest rate path to move up a bit in order to keep medium-term inflation at 2%,” he said.

He nevertheless rejected the idea that the ECB should accelerate the tightening with a 50bp move.

“No, not really,” Šimkus said when asked whether a half-point increase might be appropriate. “Fifty basis points would require a really dramatic change in the inflation environment — something of the kind we saw after the pandemic. We are not in that situation, so we do have time to act and to take reasonable steps.”

“A 50bp hike is definitely out of my scope,” he added, saying he did not believe the ECB was currently in danger of falling behind the curve.

Šimkus pointed in particular to persistent domestic inflation pressures. Core inflation was gradually increasing, while elevated services inflation was “reflecting persistent domestic price pressures, including those related to wage growth and domestic demand,” he said.

He also cited higher gas futures prices, historically low gas inventories and more expensive wheat and other food futures, while noting a recent increase in consumer inflation expectations.

The underlying strength of the economy was another reason not to underestimate inflation risks, Šimkus said, rejecting the argument that recent resilience could be ascribed to transient fiscal impulses.

“I don't attribute the economic resilience solely to fiscal support. This would be too narrow an explanation for this situation,” he said.

“To some extent we fall into the trap of this narrative that the European economy is somehow inherently less competitive, more stagnant, etc. I think it’s actually much more resilient than we typically realize,” he said.

Šimkus pointed to reduced dependence on fossil fuels, the increased importance of renewable energy, continued household spending and manufacturers bringing production forward in the second quarter ahead of anticipated higher energy costs.

“So it's a mixture of factors explaining why the economy appears to be more resilient now than we were expecting a couple of months ago,” he said. “But overall, I think we should have more confidence in the European economy than we typically do.”

Šimkus said he was not particularly concerned about the recent rise in European long-term bond yields.

“It's very difficult to disentangle the precise reason,” he said. “Various factors could explain the rise, starting with term premia, inflation, monetary policy expectations, changes in supply and demand, also potential implications coming from the U.S. Treasury market.”

“I’m not particularly worried about it; I think this is a general market development reflecting a variety of things,” he said, adding that markets were constantly reassessing the outlook and policymakers should not “overreact to every change in the economic, monetary and financial environment.”

Šimkus acknowledged that the rise amounted to a tightening of euro area financial conditions that the ECB had to take into account, but said it partly reflected the changed inflation environment.

“To some extent, markets are already doing some of the tightening, which is then ultimately confirmed, if I can put it that way, by the ECB’s decisions,” he said.

On policy communication, Šimkus backed the ECB’s existing meeting-by-meeting, data-dependent approach rather than a return to forward guidance.

“We have to admit and be honest: the data are changing, and changing quickly, so this meeting-by-meeting, data-dependent approach is the right one and probably the only one that fits the situation,” he said.