Exclusive: ECB’s Šimkus: Could Get Back to Discussion of Whether to Do More on QT Early Next Year

19 July 2023

By David Barwick – VILNIUS (Econostream) – European Central Bank Governing Council member Gediminas Šimkus on Monday said that pending a careful examination of all pertinent factors, the ECB might want to consider the possibility early next year of picking up the pace of quantitative tightening with respect to its asset purchase programme (APP).

In an interview with Econostream (transcript here), Šimkus, who heads the Bank of Lithuania, appeared however notably less inclined to touch the ECB’s pandemic emergency purchase programme (PEPP).

Time was not on the side of the ECB’s efforts to get inflation under control, he said, expressing clear support for a rate hike at next week’s Council meeting along with the desire to discuss at the September meeting the possibility of a further increase in official borrowing costs.

With respect to QT, ‘I think we should be open-minded’, he said. ‘And depending on the economic situation, and on the inflationary developments, we could get back to a discussion whether we should do more on that front, referring again only to the APP, maybe in the beginning of next year. Other central banks like the Bank of England and the Fed have already started active selling.’

The PEPP was another matter, he made clear. Any possible modification of forward guidance in this respect would ‘require careful deliberation, taking all the aspects into account’, he said. ‘And what's also important from the perspective of the PEPP is that reinvestments serve as the first line of defence against fragmentation or transmission risk. But we have the APP and we could do more on that front first.’

Although the latest PMIs had indicated economic deterioration, the euro area labour market was still robust, with unit labour costs on the rise, whilst inflationary pressures remained strong, he said.

‘So, I feel comfortable saying today that there is a clear need for another hike in July, and that a hike should be one of the options we discuss in September’, he said. ‘And therefore, I would not be surprised if we continued to hike in September.’

Even if headline inflation receded further by the September meeting, ‘I don't expect to see much weakening of core inflation’, he said. And whilst economic performance could also deteriorate, ‘this does not come as a surprise’, given 400bp of monetary tightening to date, he reasoned.

‘And again, I wouldn’t be surprised by a hike in September, but in the context of the current moment, all I can say with certainty is that we need another hike in July, and I don't think we will have such quick interest rate cuts as some market participants expect’, he said.

Interest rates needed to be raised to a level of restrictiveness consistent with returning to price stability and then to remain at that level ‘long enough to make sure this happens’, Šimkus said.

Expectations of some observers that the ECB could loosen monetary policy before the end of this year or early next year were not ‘a very plausible scenario unless we see some unexpected changes in economic activity or inflation’, he said.

‘Life seems to be full of black swans, especially in the last few years, but if the economy evolves as we currently foresee, I would say we will remain in restrictive territory for longer than a lot of market participants expect’, he added.

For any loosening of the monetary reins to occur, both headline and core inflation would need to be seen stably at 2% in the medium term, he said.

At present, elements of the situation with respect to inflation remained concerning, he indicated, noting that the last forecasts had brought only a slight revision of headline inflation and that core measures seemed to be ‘stickier and more entrenched.’

Labour markets were robust, and increasing unit labour costs supported core inflation, he said. Profit margins ‘made a quite important contribution to inflationary pressures last year’, and it remained to be seen whether weaker economic developments would attenuate this source of pressure, he said.

‘So far, we’ve been quite successful in anchoring inflation expectations, but time is working against us’, he cautioned.

‘The longer you have elevated levels of inflation, especially in sectors people notice on a daily basis, like food, utilities and services, then you get greater efforts to compensate for the increase in prices’, he said. ‘So, time is working against us, and at this point, the risk of doing too little is still higher than the risk of doing too much.’

Current data were more or less in line with the ECB’s most recent baseline scenario, Šimkus said.