Exclusive: ECB’s Kazāks: ‘There is no pivot. We still say that inflation is a problem, and we will keep raising rates’

7 November 2022

- Kazāks: ‘Discussion about the size of the step is appropriate and of course there will be one’
Kazāks: December step size depends on economy and on whether we adjust other instruments
Kazāks: Adjusting other instruments could improve policy transmission to all segments of economy
Kazāks: ‘There is no need to take a pause at the turn of the year, we should continue hiking into next year’
- Kazāks: Any recession ‘likely to be relatively shallow and short-lived, and this would not lead to rate cuts’
- Kaz
āks: Situation ‘becoming more nuanced’, so natural that our discussions reflect greater ‘diversity of views’

By David Barwick – RIGA (Econostream) – The European Central Bank is likely at some point to fine-tune monetary policy using smaller rate hikes, and an increasingly nuanced situation could motivate discussion of a reduced step size next month, but it is too soon to say whether decelerating in December would be appropriate, Governing Council member Mārtiņš Kazāks said Thursday.

In an interview with Econostream, Kazāks, who heads Latvijas Banka, expressed the clear conviction that the monetary reins needed tightening in any case into next year, and voiced support for aligning all the ECB’s instruments with interest rates, a process he suggested could continue with a passive run-down of the asset purchase programme (APP) in the first quarter.

As to whether the December monetary policy meeting would be the moment to reduce the size of the ECB’s rate steps following the 75bp moves of September and October, Kazāks said that ‘there will be big discussions about 50bp, or 75, or whatever else’.

‘The discussion about the size of the step is appropriate and of course there will be one’, he continued. ‘We already see public discussion about the size of the December step, but at the same time, nobody is saying that there shouldn’t be any step in December.’

No one could credibly commit to a particular magnitude in December as of today, he said, pointing to the many different pieces of relevant information to become available between now and then.

‘We are very clear that we are not yet where we need to be and interest rates have to go up’, he said. ‘Whether we move by a bigger or smaller step in December depends on how the economy performs and on whether we complement a rate hike by adjusting other instruments. It’s still too early to say.’

With respect to what instrument could complement a rate hike smaller than the previous two, Kazāks placed the question in the context of aligning the ECB’s various instruments ‘so that they support each other rather than fight against each other.’

‘Including a broader set of instruments can potentially improve monetary policy transmission to all segments of the economy’, he elaborated. ‘And that could make it possible to reduce the size of the rate steps by complementing them by other things. So that’s a possibility, but I’m not saying now that we should consider such a trade-off in December.’

Kazāks denied that the ECB was preparing a dovish policy pivot, notwithstanding certain new elements of ECB President Christine Lagarde’s communication at the October 27 press conference.

‘I don’t think anything has materially changed’, he said. ‘Is there an expectation in the market that it’s going to be 75bp forever? Be realistic. When we see that bigger steps are necessary, then we take bigger steps. We’ve very clearly said that the job is not done yet and we need to keep hiking. By how much? We’ll see from meeting to meeting. There is no pivot. We still say that inflation is a problem, and we will keep raising rates.’

All the same, it would be odd if, as ‘the situation is becoming more nuanced’, Governing Council deliberations did not reflect an increased ‘diversity of views’, he said.

‘That is part of the job, and my own view is that we still need to raise rates to remove accommodation’, he said. ‘There is no need to take a pause at the turn of the year, we should continue hiking into next year, and the specific size of the steps we will discuss each time.’

That said, the importance of getting policy just right meant that rate steps would eventually slow, he said. ‘That would be reasonable because of the need to do fine-tuning’, he said. ‘You can’t stop a car on a dime, or everyone flies out of the window. A smart driver comes to a gradual stop, not an abrupt one.’

As for other instruments, with the decisions made in October concerning the TLTROs and the remuneration of excess reserves, it would be logical to turn next to the APP, he reasoned: ‘The policy accommodation of the APP isn’t appropriate anymore, and if a central bank market intervention isn’t needed, then we have to withdraw from the market.’

Discussion of assets acquired under the pandemic emergency purchase programme (PEPP), in contrast, ‘shouldn’t start yet – there’s no need’, he said. In general, however, the discussion that Lagarde indicated was underway with respect to QT will continue next month, he said.

While some decision pertaining to QT could thus emerge from the December 15 meeting, the communication of a precise sequence of steps wouldn’t necessarily be forthcoming, he indicated. ‘We know that forward guidance in times of uncertainty is not always helpful’, he said. ‘But from today’s perspective, in my view it would be appropriate to introduce an element of balance sheet adjustment via the APP early next year unless the economic outlook changes sharply.’

Asked whether the time to actively sell parts of the ECB’s balance sheet could come in 2023, Kazāks said he ‘would not jump that far ahead, because uncertainty is very high’.

He continued: ‘We should not delay the start of QT too much, but at the same time we should be cautious, because we want the transmission mechanism to work. Later on, we should and will talk about actively selling our asset holdings. But it’s still way too early for that.’

Kazāks hesitated to back the view that the modification of the TLTRO conditions would ease pressure on the ECB to unwind its balance sheet via QT. I would look at them as addressing two different segments’, he said. ‘But a reduction in TLTRO money of course would align our instruments more with the interest rates.’

Even with early repayments of the TLTROs and the consequent reduction in liquidity, it would be ‘perhaps years that we will continue to see excess liquidity in the system, given how much is there’, he said, leaving the deposit facility rate the relevant key interest rate for some time to come.

The idea of maintaining reinvestment of maturing securities at least until TLTRO repayments have been absorbed did not win Kazāks’ endorsement. ‘I would refrain from that specific sequencing of instruments’, he said.

Predictions of some bank analysts that the ECB would find itself reversing course toward the end of next year and already cutting interest rates again were unlikely to be fulfilled, he said.

‘It would most likely require an extremely sharp and deep recession, which currently is neither the ECB’s baseline nor even the most likely negative scenario’, he explained. ‘The risk of recession is there, and my personal view is that the risk of recession in the euro area has become the baseline. But it’s likely to be relatively shallow and short-lived, and this would not lead to rate cuts.’

In other comments, Kazāks advocated a risk management approach to monetary policy, arguing that losing control over elevated inflation was likely to ultimately entail more severe consequences than leaning too hard against it.

If the choice is between overdoing it on the one hand and underdoing it and then coming back to deal with the problem again on the other, then it is better to choose the first option’, he said. ‘I don’t actually want to overdo it of course, but I think the risks of underdoing it and then dealing with the regime change of switching from a low to a high inflation environment is much costlier to society. I think underdoing it is a significant risk that we should be very aware of, because underdoing means letting high inflation take root, and that would be very problematic.’