Exclusive: ECB’s Holzmann: ECB Hopefully ‘Moving Towards a Terminal Rate Somewhere Above 4%’

16 May 2023

By David Barwick – VIENNA (Econostream) – The European Central Bank is hopefully heading for a terminal rate of somewhat above 4%, even if the smaller moves that are now likelier to characterise monetary tightening could imply hiking interest rates beyond the summer, according to ECB Governing Council member Robert Holzmann.

In conversation with Econostream (transcript here) on the margins of a speaking engagement, Holzmann, who heads the Austrian National Bank, argued that such a terminal rate was required by the current inflation situation, but would also have the advantage of facilitating progress on reducing the ECB’s swollen balance sheet.

‘As long as we’re below 4%, we won’t be at a level of interest rates that allows us to pause and wait to see how things develop’, he said. ‘I think we need to go beyond a 4% interest rate in order to draw even with the US – again, taking into account the different levels of r* - and it’s just a matter of whether we should go faster or slower.’

‘My assessment would be that faster would be more appropriate, in order to get to our terminal rate without wasting time’, he explained. ‘Because in such a case, ultimately, it also means that we can come back down sooner. Whereas if we go up slower, it is likely to require that we stay high for longer.’

In response to the assertion that rate hikes of more than 25bp had probably become infeasible following the deceleration in the pace of monetary tightening two weeks ago, Holzmann described this development as ‘the problem.’

‘That’s exactly the reason why I wanted to have 50bp, because in this case we would have gotten to 4% faster, in just two moves, and perhaps then we would do a little bit more’, he said. ‘But unfortunately, the decision was another one, and so we have to move more slowly, which means that to get to 4% we need to take three more steps, and to get above 4% we need four more increases. As things are currently, that’s to get to the level we need to be at to deal with inflation.’

It would take a ‘miracle’ for the ECB to be able to stop sooner, and the data did not suggest that one was coming, he said.

‘[C]ore inflation has barely budged’, he reasoned. ‘It’s still very high, and although the rate hikes we‘ve already taken are beginning to have a small effect, I don’t think it will come down much more this year. Maybe a little bit.’

The ECB needs to take care not to get behind the curve, he cautioned, as this could ultimately require a ‘much more rigorous and forceful’ policy response down the road.

The Council's decision this month to stop all reinvestments under the Asset Purchase Programme (APP) as of July was correct, he said, though not without qualification. ‘The thing is, I agree with the decision, but the problem is that moving faster with the APP will of course mean that we have to sell outright from our inventory of assets sooner, which can only be done at a loss’, he said.

The APP may therefore not offer much possibility of accelerating QT further, which ‘means that we will have to turn to the PEPP [Pandemic Emergency Purchase Programme]’, he said. However, this also has a downside in that involving the PEPP could compromise the programme’s usefulness as a flexibly deployable market instrument, he observed.

‘It will have to happen, but it won’t be an easy ride’, he remarked.

The ECB will first have to alter forward guidance with respect to the PEPP, he agreed. ‘But I would prefer to have the interest rate decided first, and only afterwards have the change in QT with respect to the PEPP, in order to have an anchor for the interest rate policy before we involve PEPP in our QT’, he said.

In this connection, Holzmann said that if his ‘wish were to come true, we would be moving towards a terminal rate somewhere above 4%.’ Even if it were too early at present to clearly identify the terminal rate, he said, ‘if we reached a rate above 4%, we could more easily decide about the PEPP.’

In other comments, Holzmann expressed support for a corridor system over the alternative of a floor system. The ECB intends to review its operational framework, in the context of which it will have to confront this question.

‘The advantage of the floor system is its simplicity’, he said. ‘The corridor system requires a bit more work, but the beauty of it is that it offers room for private markets.’

It was hard to imagine that the United States government would not come to an agreement in the end with respect to its fiscal affairs, he said. A compromise always emerged in the past, he noted.

‘We all hope that this will be the case this time, too’, he said. ‘Of course, there’s still a tail risk that there won’t be any compromise, but it would be a disaster, not only for the US, but for the rest of the world too.’