ECB Insight: Knot’s Hawkishness Dialled Down Yet Another Notch

6 June 2023

By David Barwick – FRANKFURT (Econostream) – European Central Bank Governing Council member Klaas Knot on Tuesday again sounded markedly less hawkish than in the recent past, reassuring that the worst of inflation had passed, rejoicing at monetary tightening’s initial impact on the real economy, and arguing that financial stability risks warranted proceeding with further rate hikes cautiously.

Current inflation of just over 6% was ‘still way too high’, he said in a speech in Luxembourg. ‘But I do believe that, in the absence of further supply shocks, the worst is behind us in terms of the immediate assault on our citizens’ purchasing power.’

The assertion that ‘the worst is behind us’ is not wholly new, Knot having already opined on 25 May that ‘the peak in headline inflation is clearly behind us’. At that time, however, he also labelled core inflation ‘our biggest concern’, said that there were ‘no signs of abatement here yet’ and warned that ‘once inflation reaches wages and services, it becomes even more persistent’.

Compared with that, he was more relaxed today, saying only that ‘price pressures in these areas [wages and services] will prove more difficult to bring down’ and then immediately confirming that ‘despite all of this, inflation expectations are still decently anchored’.

Or consider his demand two weeks ago for ‘more robust evidence on the impact of our monetary policy decisions.’ The contrast is hard to miss with his assurance today that ‘it is reassuring to see the first signs of recent monetary policy actually being transmitted to the real economy’, which he followed by citing various examples of monetary tightening’s effects.

There was also Knot’s worry about the threat of financial instability, a risk that he said on Tuesday ‘looms around the corner’, as any sudden monetary policy shift ‘could also trigger some of the vulnerabilities that have accumulated in the past.’

His concern about the impact on the financial system of hell-for-leather monetary tightening has not dissipated, at a minimum. Five days ago, Knot, who heads the Financial Stability Board, gave a speech on the resilience of the financial system in which he said that ‘the pace of the recent [interest rate] increases and the adjustments financial markets and institutions need to make as a result are cause for concern.’

Today, however, he also drew dovish conclusions for the pace of further policy tightening, saying that this would have to proceed ‘step by step’, given that each step requires adjustment by the financial system that ‘cannot be taken for granted.’

That Knot in any case called today for rate hikes to continue ‘until we see inflation return to our 2% target over the medium term’ means little. For one thing, we see this as a rather generic platitude to which any member of the Governing Council should be able to subscribe at least nominally, inasmuch as it amounts to scarcely more than a restatement of the ECB’s price stability mandate.

More importantly, the voicing by Knot of more hawkish preferences is conspicuous by its absence. Two weeks ago, he made no bones about the need ‘at least’ for 25bp rate hikes in June and July.

True, he also said at the time that as for the further evolution of monetary policy ‘after the summer, I am totally open’, which already constituted a tentative shift in a dovish direction.

For this reason, we don’t argue that it is only today suddenly evident that Knot’s appetite for rate hikes is nearing its limit, the statement about being 'open' having been an early first indication of approaching satiety. His latest intervention underscores this impression.

Given Knot’s status as one of the most hawkish members of the Governing Council, his waning support for further interest rate increases casts a shadow over the prospects for the possibility of these post-July.

It was only yesterday that another prominent member of the hawkish camp appeared to double down on the potential need for a terminal rate north of 3.75%.

‘As things stand, several interest rate steps are still needed’, Bundesbank President Joachim Nagel said in a speech. ‘In my view, it is by no means certain that interest rates will reach their peak as early as this summer.’

Whilst we suspect that Nagel’s hawkish rhetoric is motivated somewhat by purely tactical considerations and he wouldn't exclude that 'several' could be no more or less than two, it remains the case that Knot, who until now has hardly been shy about pushing the envelope in favour of higher borrowing costs, seems less willing to support his German colleague’s effort. This is a circumstance that to our mind should not encourage bets on a September hike.