Nagel Calls For Further Rate Hikes and Substantial Reduction of ECB Balance Sheet

3 July 2023

By Xavier D’Arcy – FRANKFURT (Econostream) – The European Central Bank still has distance to cover, even if it raises interest rates again in July, ECB Governing Council member Joachim Nagel said on Monday.

In a speech at a finance conference in Frankfurt, Nagel, who heads the German Bundesbank, said that the ECB’s future operational framework should facilitate a substantial reduction in the size of the Eurosystem’s balance sheet and allow the market more room to operate.

‘Whether interest rates need to be further increased after the July meeting will be decided based on future data developments’, he said. ‘As I see it, we still have a distance to cover.’

The upcoming decision on the ECB’s future operational framework should ensure that ‘the market should be given more room to operate’ and ‘the central bank's balance sheet should be reduced to a significantly lower and sustainable level within an acceptable timeframe’, he argued.

‘From my perspective, there is a strong case for the central bank's footprint in the market to become significantly more transparent in the future’, he said, adding: ‘This would especially mean having a much smaller balance sheet.’

‘For these reasons, I advocate for a substantial reduction in the balance sheet of the Eurosystem in the coming years’, he concluded.

Despite the fact that it was ‘encouraging that the inflation rate has significantly declined since its peak last autumn’, core inflation did ‘not yet show a clear downward trend’, he said.

The uptick in core inflation in June showed that ‘underlying inflation is thus more persistent than the decline in the headline rate suggests.’

Recent ECB forecasts showed ‘that a swift return to the 2% target is far from certain’ and ‘upside risks dominate the outlook’, he said.

He predicted that ‘doubts about the necessity of further interest rate hikes will increase’ and ‘[c]ritical voices will grow louder, raising critical questions’, as the ECB approaches the terminal rate and keeps policy restrictive for a prolonged period of time.

The current outlook for the Eurozone was ‘not so bleak’, he said, noting that recent ECB projections did ‘not anticipate an increase in unemployment.’

‘On the contrary, the labour market is robust and tight, which could potentially lead to significant wage increases’, he said. These developments showed that there were ‘no indications from the real economy that suggest excessive tightening is taking place’, whilst ‘financial market data does not support such concerns’ either, he added.