Exclusive: ECB’s Kazāks: Rates Need to Keep Rising After March, But Too Soon to Say How Fast or How Much

9 February 2023

Exclusive: ECB’s Kazāks: Rates Need to Keep Rising After March, But Too Soon to Say How Fast or How Much
- Kazāks: ‘Getting to 3% in March is a good choice that … will take us into restrictive territory’
-
Kazāks: ‘Rates will need to go up at further meetings’ even after March; 'we are on a solid path of rate increases'
-
Kazāks: ‘At some point we’ll reduce our speed’, but ‘by no means’ in March
- Kazāks: Hiking more than 50bp in March ‘would be reckless’, not needed in view of previous steps
- Kazāks: Too early to say how big May rate hike should be
- Kazāks: ‘Quite likely that there’s not going to be a recession at all’
- Kazāks: Once at terminal, expect to ‘stay there for an extended period’; rate cut in 2023 would be 'way too premature' 
- Kazāks: ‘Terminal rate is by no means 3%, that has to be clear’, but ‘I also don’t think we will go as high as the US’
- Kazāks: Baseline would be ‘more benign inflation projections in March, but there are risks on both sides’

By David Barwick – FRANKFURT (Econostream) – The European Central Bank should continue raising interest rates without pausing even after a very likely 50bp increase in March, Governing Council member Mārtiņš Kazāks said Tuesday.

In an interview with Econostream, Kazāks, who heads Latvijas Banka, said that whether May would be the time to slow the pace of tightening somewhat could not be clear so far ahead of the meeting, but indicated that at some point monetary authorities would want to fine-tune their stance with hikes of less than 50bp.

‘Of course, we as decision makers should be open to discussing alternatives’, he said with regard to next month. ‘But given the inflation and economic dynamics so far, the fact that we are only at 2.5% and that the pro-cyclicality and latent nature of r* make it very difficult to be sure that we are already in restrictive territory, getting to 3% in March is a good choice that will be effectively transmitted and, in my view, will take us into restrictive territory.’

‘But it is by no means the end of the cycle’, he added. ‘I see no reason to stop or pause at 3%. Rates will need to go up at further meetings. How far exactly will depend on the data.’

Previous monetary policy steps were now unfolding their impact, as seen in the ECB’s latest Bank Lending Survey, he said. ‘But rates are still not restrictive enough to see inflation coming down sustainably to 2% sooner than 2025, and in my view, that’s just not timely enough’, he said.

Despite the clear need to hike rates beyond March, Kazāks rejected the idea of bringing some of that tightening forward by doing yet more than 50bp at the Council meeting in five weeks. For one thing, he reasoned, ‘it is just natural to start thinking that at some point we’ll reduce our speed’ in recognition of the more even balance between the risks of doing too much and doing too little, even if this would ‘by no means’ be the case already in March.

Moreover, monetary authorities must be sure that policy transmission does not become an issue, he said. ‘Why should we overreact with a jumbo hike and take the risk that it is not transmitted properly?’, he asked rhetorically. ‘That would be reckless.’

Finally, a hike larger than 50bp in March would not duly acknowledge that the ECB has already made significant decisions whose impact is now ‘just working through the economy’, he said.

As for whether a deceleration to 25bp would be appropriate in May, Kazāks was not ready to prejudge the precise outcome of a Governing Council meeting still three months off, preferring instead to emphasise again the very likely need to hike by 50bp in March and to continue tightening in May with a step whose exact magnitude was best determined later.

‘We are on a solid path of rate increases’, he said.

Kazāks took issue with the idea that the ECB would start backtracking and loosen the monetary reins as soon as this year. ‘That’s way too premature’, he said. ‘Wage pressures are likely to be sustained, and pay increases don’t even need to be sky-high to make inflation more persistent.’

A first rate cut in 2023 could from today’s perspective only be ‘a risk scenario in which some shock pushed the economy into a deep recession, thereby sharply reducing inflationary pressures’, he said. ‘But this is not even a part of most likely risk scenarios. For me it is from the category of unknown unknowns. So, I don’t see why the rates should come down as quickly as markets expect. I expect them to go up and stay there for an extended period.’

History showed that loosening tight policy prematurely could lead to a resurgence of inflation such that in the end, policy would need to do more than otherwise at the expense of the economy and employment, he warned.

Kazāks observed that recent developments would be reflected in the updated macroeconomic forecasts in March. ‘We’ve seen energy prices coming down and this is likely to pull headline inflation down significantly, though the other measures will be much stickier’, he said.

‘This does not mean that we should stop tightening monetary policy’, he said, however. ‘I would take a very close look at underlying inflation measures, wage pressures, inflation expectations and the economy overall.’

One element of a situation in which further monetary tightening could lose its appeal for Kazāks was a ‘clear turnaround’ of core inflation, he said. Still, there was no automatism about the relation between policy and key variables, given the importance of the larger context, he said.

In this respect, he cited the example of China’s reopening and the uncertain nature of its ultimate ramifications for global and euro area inflation.

Moreover, even if cheaper energy exerted downward pressure on inflation, the next set of forecasts would also have to take into account that whereas the ECB and many observers had been expecting 'a short, shallow, technical recession, it’s quite likely that there’s not going to be a recession at all’, he pointed out.

‘A recession would likely not have been strong enough to resolve the inflation problem anyway, but without any recession at all now, the labour market will be even stronger than expected, and that is likely to induce more persistence in inflationary processes’, he said. ‘So overall, yes, the baseline scenario would be to see more benign inflation projections in March, but there are risks on both sides.’

Given the continued high uncertainty, Kazāks declined to confirm that the ECB’s hiking would not extend into the summer, and, as previously, would not be too specific about where the ECB’s terminal rate could turn out to be. These things would ultimately depend on how much tightening it took to contain inflation, he said.

‘But the terminal rate is by no means 3%, that has to be clear’, he said. ‘3% is not good enough. I also don’t think we will go as high as the US. But where exactly the number’s going to be, nobody knows.’