ECB’s Knot: Need to Prepare for Upside Scenarios

9 November, 2021

By David Barwick – FRANKFURT (Econostream) – The economy is going to require considerable policy support for quite a while, European Central Bank Governing Council member Klaas Knot said Tuesday.

In remarks at the UBS European Conference, Knot, who heads De Nederlandsche Bank, said that currently high inflation would persist ‘at least’ through the rest of 2021 and that HICP would subside below 2% ‘towards the end of next year.’

‘But upside risks to this baseline dominate’, he added. ‘And we need to prepare for upside scenarios as well.’

Although some inflationary pressures are transitory, such as those stemming from supply bottlenecka and energy prices, ‘these transitory pressures are not necessarily short-lived’, he said. ‘In fact, we have come to realize that the inflationary pressures from these sources last longer than initially thought.’

Moreover, durably higher inflation hinges on wage growth, he observed, and ‘if inflationary pressures were to persist longer, while the recovery matures and the labor markets conditions become tighter, higher wage increases will become more likely.’

The link between the duration of transitorily high inflation and the likelihood of an impact on wages means that ‘our assessment of future wage developments will be very important in the period to come’, he said.

Knot backed up ECB President Christine Lagarde’s assertions that an interest rate hike next year was unlikely, based on the conditions that had to be met for this, and that the ECB’s pandemic emergency purchase programme (PEPP) would probably end next March.

Policymakers ‘should not be complacent about upside risks to inflation’, but rather ‘maintain a degree of policy optionality’, he said. He rejected making ‘long-lasting unconditional commitments that might end up being incompatible with how the inflation outlook develops.’

Whether the asset purchase programme (APP) would need expanding in the context of the PEPP’s end ‘is not clear-cut’, he said. ‘While we will definitely aim to prevent cliff effects, it very much depends on the inflation outlook whether we will need a durably higher purchase pace.’

Should inflation prospects change, the APP would be the ‘appropriate instrument of marginal policy adjustment’, he said.

As for the PEPP’s flexibility, some of this will probably be lost in the transition. An assessment of the proportionality of preserving the flexibility will be needed, he said.