Exclusive: Transcript of Interview with ECB Governing Council member Kazāks on 29 June 2024

2 July 2024

By David Barwick – FRANKFURT (Econostream) – Following is the full transcript of the interview conducted by Econostream on 29 June with Mārtiņš Kazāks, Governor of Latvijas Banka and member of the Governing Council of the European Central Bank:

Q: Governor, my first question has to do with the Governing Council’s recent so-called retreat. One governor said he left Ireland with the impression that people would prefer to change very little about the ECB’s strategy. But why change anything? It’s only been a short while since 2021.

A: Back in 2021 we agreed to do a review of our strategy more often than in the past. But it makes sense to do it not only because we agreed to, but also to take stock of our strategy in a changed economic environment. I see no need for a massive overhaul involving discussions of all the topics we dove into in 2020 and 2021. Our 2% medium-term symmetric target has served us very well and is much better than the previous one, which was not as easy to understand. Its clarity helps anchor inflation expectations. So, for me, as far as the target goes, let’s continue with it. There are other issues it would be nice to discuss. When we did the last strategy review, we had been in a long period of below-target inflation. The environment now is very different. So, we were very interested then in policy at the effective lower bound, and now we have more experience in dealing with that situation. There are issues to be discussed about the macroeconomic environment, geopolitical shifts, supply chains and how to react to a series of supply shocks. And we should discuss our experiences with the use of QE and QT. It’s true that we don’t expect to go back to the effective lower bound anytime soon. But life is uncertain and things can happen, so it’s important to have this instrument in our mix of policy measures. And I believe in the principle that we should not do what the market can do, so there needs to be discussion of demand-driven QE versus supply-driven QE. For instance, the experience with TLTROs, which drop out of the balance sheet relatively quickly, being demand-driven. I’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 pricing mechanisms of bank lending, i.e. fixed or floating rate loans, and its impact on monetary policy transmission are another element to look at. And the massive dispersion of inflation rates across countries, which was unexpectedly wide. So, there are some specific topics to discuss, but there is no need to peer into every corner the way we did last time.

Q: At least one governor feels that the operational framework cannot be separated from monetary policy, because the latter is not independent of the framework, so that the operational framework review and the strategic review should be merged. Do you see such a need?

A: That was in a way my view also, that you can do everything at the same time. The operational framework and monetary policy are of course linked. We agreed however to split it up. That’s fine; we can do it like that. A discussion of the size of the balance sheet is necessary, and this is a topic I would like to see discussed more next year. But we are in no hurry to come to a conclusion by some given date, and the balance sheet is continuing to shrink.

Q: Turning to monetary policy, you’ve said that if the earliest date the target is hit moves beyond 2025, then restriction needs to be maintained for longer. How worried are you about this outcome?

A: Our target is 2%, symmetric and in the medium term. The medium term is not clearly defined, but we’ve had above-target inflation since the second half of 2021, and four years is a long medium term. I don’t think pushing it out further would be appropriate. A second point is that anchored expectations allow for more stability and less need for higher interest rates. The credibility of the target and the anchoring of expectations make a significantly lower sacrifice ratio possible. We need to safeguard this credibility, and pushing out the date when 2% inflation is reached might undermine it. So, let’s get to 2% without accepting excuses for doing it a quarter or half-year later. Another thing is the high uncertainty. There are many risks that could push reaching 2% inflation further out. These aren’t the baseline, but they make it even more important to get to 2% in a timely manner.

Q: Given these concerns, should the ECB not make clearer that if the situation calls for it, and only if, then a hike is also always an option?

A: But this is part of the deal. Deviations from our symmetric target are equally undesirable on both sides. It’s very clear that if there will be a need to hike rates, we will do so. But under the baseline scenario, which is the most likely, we see inflation coming down to 2%. So, the trajectory for interest rates is downward, and the only questions are the pace and the terminal rate of the easing cycle. If the baseline scenario changes, then of course interest rates can go both ways.

Q: Do you regret supporting the 6 June rate cut?

A: No. It was appropriate to cut. Uncertainty is high, and we said that inflation would be bumpy and likely to mostly move sideways until quite late in the year. There will be positive and negative surprises and the numbers will jump around. Let’s keep calm and not make too much out of single data points that don’t represent a trend. Disinflation has made very rapid progress and we are still on a path to 2%. That’s the baseline scenario. 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.

Q: It might have been better for the ECB to wait until it was more certain another cut could come within a reasonable time. As it is, we don't even know if there will be another cut in September.

A: The direction is very clear. With the current economic environment and baseline scenario, rates will go down. The timing of the next step remains uncertain, but the easing cycle doesn’t require uninterrupted reductions at each Council meeting. And President Lagarde clearly hinted at that when she spoke of different phases. We last hiked in September. Then we stayed there for nine months before we saw that we could start reducing restrictiveness. The data will tell us when the next step will be. We simply don’t know yet. But I would point out that the baseline scenario includes quite strong wage growth this year, so what we saw in the first quarter was no surprise and still consistent with our expected outcome. We're also seeing that profit margins have softened and are absorbing some of the wage increases. We still want to see what happens with productivity, which has been pale recently. With growth picking up, there should be cyclical elements that boost productivity. So, uncertainty and risks are still there, meaning we need to be cautious. But the path for rates is downwards.

Q: It’s evident that nothing will happen in July, given a lack of new information. But if there's no cut in September, it gets harder to say the direction is clear, because it's not clear if we're not actually moving. So, it seems to me that a little credibility will be lost if there's not another cut in September.

A: I don’t see it that way. Our projections incorporate market rate expectations. They also show inflation dynamics moving sideways until quite late in the year. When inflation is moving sideways, it’s difficult to cut rates, because it raises questions. But one of the major elements of our decisions, which are clearly stated in our monetary policy statements, is the inflation outlook. This forward-looking element is extremely important, because if we only looked at current or past inflation, we would be backward-looking, which is not what a good central banker does. We need to consider how our policy stance affects the future. And 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. Of course, we would also need to see what happens to the rest of the economy. For instance, looking at confidence indicators, we don’t see a massive boom in confidence lately. 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.

Q: So, if between now and September all we do is move sideways and the outlook doesn’t change, then another cut is justified.

A: Yes, it would be a possibility.

Q: Because you have to reach a certain level of rates consistent with the inflation target, and you have a certain amount of time to reach that level.

A: Yes, if it would be consistent with us reaching 2% inflation in the second half of 2025. If for whatever reason we see reaching 2% inflation pushed significantly beyond the end of ’25 / start of ’26, then that would raise many more questions.

Q: Would you subscribe to the view expressed by a colleague of yours earlier in the week who endorsed market expectations of two more rate cuts this year as reasonable?

A: The market is currently pricing in between one and two more rate cuts this year, and this is quite consistent with our baseline scenario. But let’s see more data as it comes in. We are certainly not in the situation that we were in at the turn of the year, when market rate pricing was outrageous and clearly inconsistent with our baseline.

Q: Meanwhile, another colleague has suggested there might only be one more rate cut this year.

A: We have two more projection exercises this year, in September and December. My message to the markets is very straightforward: stay calm, don’t overreact to any one data point. Currently we are largely within the baseline scenario from March. There are lots of uncertainties and risks, such as geopolitics and the US elections, but also some political volatility in Europe, and not just France. So, let’s see what happens, and the Governing Council will do as the situation requires.

Q: Does the importance that you attach to the outlook mean that you would prefer only to move at projection meetings?

A: No.

Q: But you don’t have an updated outlook at non-projection meetings.

A: Yes, but just as an example, when you update the outlook, you might decide that 50bp would be appropriate, but you don’t want to do 50bp all at once. So, you test the water first with 25bp, and then six weeks later, if the data confirm that 50bp were warranted, you do another 25bp at the non-projection meeting. Data-dependent means that all the meetings are live meetings, even if the forecast meetings are much richer in terms of data content.

Q: So, there’s a certain natural preference for projection meetings, but no rule.

A: Right. There’s no rule.

Q: If the data in September continue to be somewhat ambiguous, what does a risk-management approach to policy say? Does erring on the side of caution imply cutting or not cutting?

A: Our mandate is price stability, defined as symmetrically 2% in the medium term. We’ve been above 2% since the second half of 2021 and expect to be at 2% in the second half of 2025. That’s four years, which is long for the medium term. So, the answer is very clear: it’s better to be cautious and try to hit the bull’s eye. We are not currently in a situation that requires a decision to err on this side or the other side. We can follow a path in-between both risks. That said, cutting too early and then being forced to hike rates is the worst outcome one could think of, as it would undermine credibility. Unless there is a massive external change, in which case you can explain your actions and there’s no policy mistake, because you needed to react to the changed environment. But if the environment doesn’t change much and you just misread the situation, cut too early and then need to hike, that would be very painful. And in terms of risk management, that would be the outcome I would most like to avoid. Waiting six weeks here or there to see where the trajectory goes does not change the story much. And if necessary, we can always also adjust the pace and the size of our moves. There is not just one unique path to 2%. But currently, I’m quite satisfied with what we’re doing.

Q: The only Council member who opposed the cut said in explanation that ‘data-based decisions should be data-based’. But everyone’s decision was based on the same data. Are the data subject to varying interpretations?

A: Leaving aside the sort of guidance we effectively gave, I would still cut rates in June, because there was no need any more for that level of monetary restriction. We’re very clearly seeing the impact of the restriction on bank lending, which is still quite subdued. We’re also seeing it in terms of confidence indicators. So, we can ease monetary restriction somewhat.

Q: How broad is the restrictive territory?

A: With regard to r*, there is the natural rate and there is the neutral rate. From an operational point of view, the neutral rate is much more important for monetary policy, while the natural rate is for longer-term discussions. As for where the neutral rate precisely is, I don’t know. It is a time-varying and latent variable. So, we have to rely on indirect measures. Looking for example at lending behaviour, I would say that we are still relatively deep in restrictive territory. How deep? I don’t know, but published estimates range between 1.5% and 3% in nominal terms. These are all point estimates that each come with their own confidence intervals. So, estimates are all over the place and the range is way too broad to base precise operational policy decisions on them. I think the only thing we can say is that we are in restrictive territory. But looking at confidence indicators and lending, r* currently is certainly not at 3.75%. Is it at 2%? I don’t think so.