ECB’s Knot: ‘Highly Unlikely’ Hikes Will Stop in March, 50BP in May a Possibility

8 February 2023

By Xavier D’Arcy – FRANKFURT (Econostream) – European Central Bank Governing Council member Klaas Knot dismissed on Wednesday the idea that the ECB would stop tightening after its next meeting and opened the door to a further 50bp hike at the central bank’s meeting in May.

‘I consider it highly unlikely that the March hike will be our endpoint’ ,Knot, who heads De Nederlandsche Bank, told a webinar. ‘We still have quite some ground to cover’, he said, ‘and if underlying inflation pressures do not materially abate, maintaining the current pace of hikes into May could well remain warranted.’ As time goes by and ECB hikes are passed through to the real economy, it would become important for the ECB ‘to fine-tune our actions’, he said.

The euro area faced ‘a potentially persistent underlying inflation problem’ that would require ‘an equally perseverant monetary policy response', he said.

‘Without a doubt, the direction of travel therefore remains up’, he said.

Asked about the current level of the ECB’s key interest rates, he answered that it ‘is clearly not sufficiently restrictive for us to bring about the return of inflation to target within the medium term.’

Inflation in the euro area ‘remains far too high’, he said, noting that measures of underlying inflation are ‘still at high levels, and show few signs of abating yet.’

Due to these factors, the ECB’s focus has shifted to ‘breaking the underlying inflation dynamics’, he said.

‘In order for us to change tack, we would need to see an improvement’ in core inflation numbers, he said, an improvement that ‘has not been visible’ yet.

The Dutch central banker said that he expected core inflation ‘to stay around this very high level for a few more months before levelling off’. Inflation in core goods was expected to start falling first, he noted, although ‘core services inflation could prove more persistent.’

The euro area economy is seeing ‘initial signs’ of the ECB’s tightening, he argued, pointing to recent credit data, which ‘gave a first hint in this direction.’ Moreover, he noted, ‘housing markets in many countries have now come to a standstill.’

‘That means lower activity that will also have a subdued impact on economic growth’, he said, predicting that soon, ‘we will begin to see some impact of our tightening.’

This lag in the effect of monetary policy ‘was one of the main reasons why in December, [the ECB] decided to step down from 75 to 50bp’, he said. The Governing Council wanted sufficient time to observe ‘how this impact would develop over time.’

According to Knot, 'the largest upward risk to core inflation is a further increase in wage growth.’ The staggered nature of wage negotiations in the euro area led systematically to ‘both to an underestimation of current wage pressures as well as a likely more persistent wage drift', he said.

The labour market was ‘structurally tight’, so that even if the economy were to slow down further than it already has, the ECB was ‘not expecting a major deterioration in labour market conditions’, he said.

Asked about the progress of quantitative tightening, he commented that ‘markets have absorbed QT so well’ and that he expected ‘very little further impact’ if the ECB continued to reduce APP reinvestments and eventually brought them to a full stop.

Such a full reduction of reinvestments ‘should ultimately be the target’, he said, though a stop to reinvestments under the PEPP was ‘outside the equation’, with the ECB committed to maintain these until at least the end of 2024.