TRANSCRIPT: Interview with ECB Governing Council member Kazāks on 08 November 2023

13 November 2023

By David Barwick – RIGA (Econostream) – Following is the full transcript of the interview conducted by Econostream on 8 November with Mārtiņš Kazāks, Governor of Latvijas Banka and member of the Governing Council of the European Central Bank:

Q: Governor, with regard to rate cuts, isn’t putting a simple discussion of the topic on hold all the way until 2024 wage developments are clearer - next April or May – excessively long?

A: There are lots of parts of the picture that we still need before discussing rate cuts, and one of these parts is wage growth. There is a real risk of wage growth spilling over into inflation. We understand of course that there should be some compensation for the inflation shock’s negative impact on real wages. But our forecast of 2% headline inflation in the second half of 2025 depends on how much compensation there is. There has been some tentative softening of corporate profit margins, which is necessary to make wage increases less inflationary. As to wage increases, no clear peak of wage growth has been seen yet. This in the context of a lot of uncertainty. Also, most of the decrease in the last month in the headline inflation was due to base effects, while core inflation is still high. At the same time, the economy is not in an outright recession and labour markets are relatively strong. So, there has to be some patience at this stage while we wait to make sure that wage increases don’t spill over. In due time we will discuss the issues of cutting, but the proper moment for such a discussion depends on the data, and it’s currently still premature to say that we’ve reached the terminal rate or that we’re near cutting.

Q: Would it not still be okay to define more clearly some sequencing of events? Should there be a period of time between reaching the terminal rate and deciding the first rate cut?

A: There are the three very clear elements of our analysis that we have communicated. So, we have said what we look at in making our decisions. Under current uncertainty, providing any sort of calendar guidance would not be appropriate, and we will only be sure that we reached the terminal rate in retrospect. So, the criteria are set out and we will make decisions on a meeting-by-meeting basis, seeing where the data go.

Q: Were you disappointed that there was no discussion of QT in Athens?

A: We will discuss all the things in due course when necessary.

Q: Why isn’t it necessary already? You, like many others, expressed the desire to see all aspects of monetary policy pointing in the same direction sooner rather than later.

A: The PEPP of course is the instrument that is very valuable in terms of the flexibility it gives us. But in general, the balance sheet story is part of the bigger issue of our operational framework, and the president said that a decision about the framework will be communicated in the spring of next year. Given that, there is still some time to discuss the issue of QT and the PEPP.

Q: Can we agree that there's also some nervousness about how the markets will handle any dramatic change in the approach that you take to QT?

A: I would say so far, so good, as far as markets go. Of course, monetary policy can only be effective when the transmission mechanism is working properly, and this depends on financial market stability.

Q: There's been very little fragmentation in the last year or so; to what extent do you think this is just because the PEPP is there and could be called on as a first line of defence if there were fragmentation?

A: Well, that’s one of the elements behind giving the PEPP such flexibility, so that we would have an appropriate instrument at our disposal to take care of disorderly and unwarranted market issues. But “disorderly and unwarranted” does not refer to all types of market volatility.

Q: But if the PEPP’s mere existence by itself is a major reason why fragmentation has been so limited recently, then that would be one reason for the Governing Council to hesitate about taking the risk of changing anything about QT.

A: I wouldn’t agree. What I was trying to say is simply that the PEPP’s flexibility could be one of the elements that has been providing some comfort to the financial markets, so one reason why they have not been very jumpy lately. But it’s clear that markets have been relatively stable, and market reactions are also very much the story of what happens with specific countries, and of what happens in terms of the U.S. spillovers. So, there’s a whole set of variables at work here, and I would not agree with the suggestion that financial markets have been stable only because the PEPP is there in the background. And we’ll get to the discussion of the PEPP, but not yet.

Q: Back to the economy, are we headed for something you would consider a period of stagflation?

A: If you take a look at inflation, it’s coming down quite sharply. In Latvia in October, the annual inflation rate was down to 2.1%. Of course, we set monetary policy not for Latvia, but for the euro area as a whole. But also in the euro area, inflation is coming down significantly. I think the important thing is that it come down sustainably. That’s why holding interest rates at their present level is currently our best option. But yes, the economy is weak, and as we’ve pointed out, the largest source of inflation was supply side shocks, and these inevitably drop out eventually. And now, ensuring that inflation really comes back to our 2% target and doesn’t increase again depends very much on monetary policy and the demand side being weakened. Why? Because we also want wage increases to be absorbed by softer profit margins. That’s the mechanism that we would like to see, but we are still waiting.

Q: Still, has the economy weakened more than you expected?

A: Under such uncertainty, the forecast error could be relatively large. But I would say that the main story has not changed: we expected inflation to come down and the economy to be relatively weak. This is all subject to some volatility, and the expected slowing of inflation doesn’t mean it will drop like a stone. It’s more likely to be a bumpy road. We see that growth is weak, and yes, it is a tad weaker than expected. But overall it is still the same story, one of weakness rather than outright recession. So, we are still within approximately the same storyline.

Q: According to the ECB’s latest Consumer Expectations Survey released today, median consumer inflation expectations for the next 12 months increased from 3.5% in August to 4.0% in September. Is this a concern?

A: Yes, it is.

Q: Some of your colleagues see further tightening as having become less necessary. Do you agree with this view?

A: We reached the point where we could put interest rates on hold, meaning not “skip” or “pause” or something like that. They are on hold at the moment, and the next step will be whatever the data tell us it needs to be. There is no automaticity about the next move. In September, there was still the feeling that we needed to hike again and make financial conditions tighter. At the moment, it still seems to me that the decision in October to put rates on hold was the right one, but what the next decisions will be, we will see. I don’t think anyone can say all the rate increases have happened, because we are reacting to incoming data, so the door for rate increases should not be shut. Let’s see what the data tell us. Overall, though, with some caveats, I could share the view that further tightening seems to have become less necessary.

Q: Can one say that you have no bias in terms of regarding either a hike or a cut as being the more likely next move?

A: I would not go into that territory yet. We will see what the data tell us. Remember that there was this interpretation of the September rate increase that it was a “dovish hike”. It was not a dovish hike. It was a hike.

Q: I’m waiting for the day when you can confirm that there’s no bias, but I guess that's not today.

A: Considering the geopolitical risks, the economic outlook and everything else, it’s too soon.