ECB Insight: Knot, Dialling Rate Hike Rhetoric down a Notch, Borrows a QT Page from Villeroy

21 November 2022

By David Barwick – FRANKFURT (Econostream) – European Central Bank Governing Council member Klaas Knot’s comments on Friday suggest that he may be backing down from his earlier enthusiasm for the possibility of a renewed 75bp rate hike in December.

Speaking at the European Banking Congress, Knot, who heads De Nederlandsche Bank, was by no means dovish, making clear that ‘risks remain tilted to the upside’, among them ‘the very real risk of second-round effects’ on the basis of ‘rising risks of a further acceleration of wage growth.’

But he can talk all he wants about the need to be ‘resolute’ in the face of such threats to price stability (‘In resolute pursuit of price stability’ was the title of the speech); the fact remains that, 27 days before the rate hike, he was atypically noncommittal about its potential magnitude.

‘Looking forward, I expect us to reach broadly neutral territory at next month’s policy meeting’, he said, a comment that would exclude neither 50bp nor 75bp. But rather than indicate a preference or even just establish the need to keep the larger option open, Knot referred to the prevailing uncertainty and the Council’s meeting-by-meeting approach.

And he didn’t stop there, but instead explicitly opened the door to smaller rate hikes. ‘As the stance of monetary policy tightens further, it will become more likely that the pace of increases will slow’, he said.

All this needs to be seen in the context of comments he made on October 30, right after the last monetary policy meeting of the Governing Council, at which time he presented the choice facing the Council at its December monetary policy meeting, then much further off, as one between 50bp and 75bp. The latter option ‘would be possible, but it’s too early to say’, he said at the time. ‘We still have six more weeks to go and there are still a lot of economic numbers coming out.’

We wrote then that ‘he may be getting ahead of himself.’ We continue to think that was the case and suspect this may be why he is now cagier, all whilst naturally wanting to sound as hawkish as ever.

Early this month, we conjectured that the ECB was setting the stage for ‘a modest reduction in the size of interest rate hikes in December, likely to be accompanied by the adjustment of another policy instrument or the announcement of specific plans for such an adjustment.’

Recent comments by Estonian central bank Governor Madis Müller, who called for another ‘substantial’ rate hike in December and said hikes of 50bp or 75bp would both meet that standard, or that of Executive Board member Philip Lane, who said today that ‘one platform for considering a very large hike, such as 75 basis points, is no longer there’, both support this.

We see Knot’s remarks from Friday as also consistent with this, the more so given he appeared to account for a slower pace of rate hikes with an appeal to ‘the switch to more varied tactics, with more instruments coming into play.’

‘The level to which the policy rate will be increased also depends on the calibration of these instruments, such as the roll-off of our bond holdings’, he said.

Indeed, Knot made some of his most detailed remarks to date on the subject of QT, fully bearing out our conviction expressed on May 26 that, despite having downplayed the probability of the matter being discussed this year, he would ‘be at the forefront of those ready to discuss QT, regardless of what he said back in May for the sake of Eurotower diplomacy.’

On Friday, it was impossible to miss his implicit endorsement of comments made on the subject more than a month earlier by his colleague, Banque de France Governor François Villeroy de Galhau.

‘It would not be consistent to keep a large balance sheet to compress the term premium, while at the same time tightening policy rates above neutral’, Knot said on Friday. Villeroy, speaking at Columbia University on October 11: ‘It would not be consistent to keep a very large balance-sheet for too long in order to compress the term premium, whilst at the same time contemplating tightening policy rates above neutral.’

Both enumerated four principles of QT.

Knot: ‘First, policy rates should remain the primary instrument to adjust our monetary policy stance.’

Villeroy: ‘First, our key interest rate should remain our primary instrument to adjust our monetary policy stance.’

Though worded quite differently, their second principle was also much the same: the asset purchase programme (APP) roll-off could start well before that of the pandemic emergency purchase programme (PEPP), reinvestments under which could or should continue through 2024, à la forward guidance.

Knot’s third principle was the ‘case for caution’, which ‘calls for an early but partial stop to reinvestments, to test the waters before calibrating the ultimate pace of the roll-off.’ This wedded elements of Villeroy’s third (QT ‘should be orderly, announced cautiously and well in advance’) and fourth principles (‘Starting slowly, assessing markets’ reaction, and gradually accelerating seems like a sound approach.’).

Such harmony bodes well for the ECB’s ability to move forward on the QT front, taking the pressure off it to continue taking outsized rate steps.