Exclusive: ECB’s Kazāks: If Inflation Moves Sideways but Outlook Doesn’t Change, a September Cut Is Possible

2 July 2024

By David Barwick – FRANKFURT (Econostream) – If euro area inflation fails to subside in the coming months but price stability is still seen being restored by the end of next year, then the European Central Bank would need to consider a further interest rate cut in September, ECB Governing Council member Mārtiņš Kazāks said Saturday.

In an interview with Econostream (transcript here), Kazāks, who heads Latvijas Banka, said that absent a significant worsening of the outlook for a return to 2% inflation in the region, another reduction in official borrowing costs should be part of the Council's September discussion.

Indeed, if bank lending and economic activity failed to stage a comeback, then this would make even more monetary easing possible, he indicated.

‘When inflation is moving sideways, it’s difficult to cut rates, because it raises questions’, he acknowledged. But ‘if the outlook still shows inflation going down as projected, then I would see another cut as possible, even if inflation readings over the next few months continue hovering around the current levels. I see no contradiction here.’

‘Of course, it is not easy to explain it, but if we maintain the outlook that we have, meaning no major changes to the baseline in September, then a rate cut should be part of the discussion’, he continued. ‘Of course, we would also need to see what happens to the rest of the economy. … If the economy and lending growth remain weak, that means the risk of inflation rebounding is lower. And that opens more possibilities for cutting interest rates.’

Kazāks countered the assertion that it was uncertain whether September would bring the next rate cut by affirming that the direction was ‘very clear’ and that, in the context of ‘the current economic environment and baseline scenario, rates will go down.’

The ECB’s baseline already incorporates ‘quite strong wage growth this year, ‘, he reminded, in addition to which ‘profit margins have softened and are absorbing some of the wage increases.’ Moreover, ‘there should be cyclical elements that boost productivity’, he added.

The 6 June rate cut was the correct decision, he said. ‘Disinflation has made very rapid progress and we are still on a path to 2%’, he reasoned. ‘So, we can start easing tight monetary policy while staying restrictive. It’s not like we’re giving gas; we’ve still got one foot on the brake, but we have room to ease up.’

Market pricing of between one and two more cuts in 2024 was ‘quite consistent with our baseline scenario’, he said.

Despite the importance of the outlook for rate decisions, the ECB should not limit itself to moving only with updated macroeconomic projections, he said. For example, were the ECB to deem another 50bp of easing appropriate at some point, it might want to split this into two 25bp steps at consecutive meetings, he said.

Confidence indicators and lending behaviour indicated that the ECB’s monetary policy was ‘still relatively deep in restrictive territory’, he said.

Turning to the ECB’s retreat in May, at which the Governing Council took a first step in the direction of reviewing its strategy, Kazāks said he saw ‘no need for a massive overhaul involving discussions of all the topics we dove into in 2020 and 2021.’

In particular, he defended the current inflation target of 2% symmetrically in the medium term, suggesting that there was no need for the question of a change here to be raised.

The Council should discuss ‘the macroeconomic environment, geopolitical shifts, supply chains and how to react to a series of supply shocks’, he said. ‘And we should discuss our experiences with the use of QE and QT.’

In the latter respect, Kazāks said that he’d ‘be happy to see the discussion include more elements related to ensuring that we don’t remain in the financial markets for too long.’

The structural size of the ECB’s balance sheet should be discussed more next year, he said, adding however, ‘But we are in no hurry to come to a conclusion by some given date, and the balance sheet is continuing to shrink.’