ECB’s Knot Sees Increasing Need to Hike Interest Rates into Restrictive Territory
15 October 2022
By David Barwick – FRANKFURT (Econostream) – It is increasingly likely that the European Central Bank will have to increase borrowing costs to the point of being restrictive, and it should start reducing reinvestment of maturing assets once interest rates are at the neutral level, ECB Governing Council member Klaas Knot said Saturday.
In a speech at a G30 seminar on the margins of the annual meeting of the IMF and World Bank, Knot, who heads De Nederlandsche Bank, said that monetary authorities anticipated further interest rate hikes ‘over the coming months.’
‘As a first step, we will increase policy rates to a level that gives us sufficient comfort that we will have entered the range of plausible estimates for neutral’, he said. ‘While the precise level of the neutral interest rate is shrouded by uncertainty, it is clear that we’re not there yet. In any case, I am increasingly convinced that we need to do more than just removing accommodation to fulfil our price stability mandate.’
Knot cited high uncertainty and ‘clear and present upside risks to inflation’ as reason for policy to err ‘on the side of resolve.’ The greater the threat of a de-anchoring of expectations, the more forcefully the ECB has to act, he said.
‘For now, and for the next few months, we will thus be guided onwards and upwards by our data-dependent and meeting-by-meeting approach’, he said. ‘I should add that I do not expect policy rate hikes to come to an abrupt end. The farther we hike and the closer we get to restoring a credible prospect of inflation moving back to target, the smaller rate steps will likely become.’
The terminal rate also depends on other instruments, among them the ECB’s balance sheet, he said.
‘Once we will have reached neutral territory with our policy rate, it makes sense to consider the roll-off of asset purchases by limiting reinvestments’, he said. ‘This would help transmitting our tighter monetary policy evenly across the yield curve and ensure that all monetary instruments work in the same direction.’
Ultimately, this would help limit inflation and reduce the terminal interest rate needed, he said.
Knot suggested moving gradually in this regard and treating the asset purchase programme (APP) separately from the pandemic emergency purchase programme (PEPP). The APP complements the policy rate, while the PEPP’s role is two-fold, given it also safeguards transmission, he said.
‘It implies that decisions about unwinding these programmes do not have to run in parallel per se’, he said.
Knot urged vigilance with respect to a possible wage-price spiral.
‘In many euro countries wage negotiations take place in the fall’, he said. ‘There are signs of substantially higher wage demands, some of which have already been met.’
‘While incidental inflation compensation is sensitive to support purchasing power, especially where wage growth has lagged productivity growth, inflation will become more entrenched if high wage increases become a repeat prescription’, he continued. ‘To prevent such vicious dynamics, central banks will have no choice but to act according to their mandate to keep inflation expectations anchored.’