Exclusive: ECB’s Kazāks: In No Hurry to Start Active Sales of Balance Sheet Assets
28 June 2023
Exclusive: ECB’s Kazāks: In No Hurry to Start Active Sales of Balance Sheet Assets
- Kazāks: PEPP reinvestment important for flexibility reasons
- Kazāks: No need for any changes to the PEPP reinvestment at the moment
- Kazāks: Balance sheet adjustment ‘very much driven by the TLTROs’
- Kazāks: Fiscal policy must become less expansionary, or rates will have to go up even more
- Kazāks: Rates should stay high ‘as long as inflation is not significantly undershooting the target’
- Kazāks: Expectation of rate cut in 1H 2024 ‘inconsistent with the baseline macro scenario’
- Kazāks: ‘We will not be done, in my view, in July, and there will be more rate hikes necessary’
- Kazāks: ‘If necessary, we can take a pause and then return to rate hikes’
- Kazāks: ‘The risks of doing too little are higher than the risks of doing too much’
- Kazāks: Lagarde ‘very skilful in getting almost all of us behind every one of our decisions’
By David Barwick – FRANKFURT (Econostream) – European Central Bank Governing Council member Mārtiņš Kazāks on Monday suggested that there was no current need to be in a rush to shift to active sales of the assets on the ECB’s balance sheet.
In an interview with Econostream (transcript here), Kazāks, who heads Latvijas Banka, defended the current forward guidance on the ECB’s pandemic emergency purchase programme (PEPP), saying that this could also remain untouched for now.
The question of when the ECB would engage in actual sales of assets was ‘still to be discussed’, he said. ‘Currently of course we still have the PEPP reinvestment, and that is also important for flexibility reasons. As for APP, we are poised to stop reinvestments from July and in due time we may start active sales, but not yet.’
Asked whether he was in any hurry to start active sales, he replied, ‘Not at the moment. The balance sheet adjustment is very much driven by the TLTROs. That’s the largest element that will trim the balance sheet this year.’
Kazāks indicated that he was comfortable with the ECB’s current guidance to reinvest the principal payments from maturing securities purchased under the PEPP until at least the end of 2024.
‘In my view, there’s no need for any changes to the PEPP reinvestment at the moment’, he said.
Interest rates are the main tool currently, but of course balance sheet reduction does go on in the background’, he said. It was important that policy space be freed up via QT, he reasoned, as if the ECB were to one day again find itself at the lower bound, ‘then the balance sheet is one of the instruments we may need to use.’
Avoiding yield curve distortion and an unduly large ECB footprint on financial markets were also important considerations arguing for QT, he added, ‘but currently the most important instrument to drive down inflation is the interest rate.’
Kazāks argued that the outcome of the ECB’s macroeconomic projection exercise should always be regarded with a healthy dose of scepticism and flanked by independent consideration of other factors such as risks.
‘I think there are always questions about the forecasts’, he said. ‘One has to take them with a pinch of salt, remain sceptical and always think “what if?”’
Still, he ‘very much’ agreed that growth risks were on the downside and inflation risks tilted upwards.
‘And this is what I think the markets are currently getting wrong when they think that rates would come back down so quickly’, he said. ‘We very clearly see in the forecasts that even in 2025, inflation is still going to be somewhat above 2%, which is simply a very long time period. It would be more appropriate to expect rates to stay at restrictive levels for longer.’
Moreover, he warned, fiscal policy needed to become less expansionary; otherwise, ‘interest rates will have to go up more, and that of course may entail financial stability risks.
Kazāks left little doubt of his expectation that a July rate hike would be insufficient.
‘I think we still have to hike in July, and in my view we still have to hike further post July, perhaps also in September’, he said. Although forward guidance was difficult under current high uncertainty, inflation was forecast to stay elevated and risks were ‘clearly’ to the upside, he noted.
‘So, from today’s standpoint, interest rates are not currently restrictive enough and I think further rate hikes will still be necessary’, he said. ‘There are many upside risks to inflation that argue for interest rates to go up higher into restrictive territory.’
Although the outlook for the economy was subject to downside risks, any weakness on that front would not sufficiently attenuate wage developments, he said.
Monetary policy could thus err on the side of doing too little and risk the return of inflation, leading to even more hiking than would otherwise be needed, or could hike rates ‘a tad too much’, he said. The latter could entail economic costs, he conceded, but these could be mitigated fairly easily by loosening monetary policy.
‘So, I still see that the risks of doing too little are higher than the risks of doing too much’, he said. ‘In my view, therefore, rates still need to go up to deal with inflation in one go, so that we don’t see inflation coming back.’
Rates should then remain high ‘as long as inflation is not significantly undershooting the target’, he said. ‘Why should we start cutting the rates if inflation just converges to our target but does not undershoot it? By cutting rates we would provide stimulus and push inflation above our target. I think that when we climb to sufficiently restrictive levels, we should be spending quite a bit of time there.’
The market expectation of an initial rate cut in the first half of next year was ‘simply inconsistent with the baseline macro scenario and goal of a timely return to 2%’, he said.
Kazāks declined to endorse the view that September at any rate should finally see the ECB hit the terminal rate.
‘Let’s see what happens in September and afterwards’, he said. ‘There are so many moving parts that it’s difficult to say. I think more rate hikes will be necessary, given current information in terms of the economic outlook, price pressures, the strength of labour markets, corporate profit margins still being quite resilient and so on.’
‘We will not be done, in my view, in July, and there will be more rate hikes necessary’, he continued. ‘In September we’ll see what happens in September, and in October we’ll see what happens in October. If necessary, we can take a pause and then return to rate hikes. Let’s see what the data tell us.’