Transcript: Interview with ECB Governing Council member Kazāks on 02 October 2024

7 October 2024

By David Barwick and Marta Vilar – RIGA (Econostream) – Following is the full transcript of the interview conducted by Econostream on 02 October with and reviewed on 06 October by Mārtiņš Kazāks, Governor of Latvijas Banka and member of the Governing Council of the European Central Bank:

Q: Governor, last month you said you'd consider an October cut if there were what you called an ‘unexpected hit’ to the economy. Is the current economic situation an unexpected hit?

A: What I said after the September meeting is that we have two major issues warranting caution. The first was the stickiness of inflation, which is still high. Domestic inflation is high, and services inflation had shown no clear downward trend in the months before the September meeting. The second major issue was economic weakness, which is a lingering problem. We are still not seeing a strong recovery of the business cycle. It remains volatile, patchy and weak, and if the recovery is delayed for too long, there is a risk of hitting a tipping point at which labour hoarding unwinds. And if this starts to happen, then it may have a snowball effect where shedding labour becomes the dominant trend. So, at the September meeting, economic weakness was of course important, but not as important as the risk of inflation staying too high. In other words, these risks at the time were not balanced. But since then, we've seen confidence turn south. Since inflation is still a problem, we need to keep a degree of monetary policy restrictiveness, but worries about economic growth have become more obvious and the risks are increasingly balanced. All this permits another rate cut in October. Of course, we still have two more weeks, and we need to be truly data-dependent, so no decisions have been made yet. In any case, even if we cut rates, we will still be in restrictive territory, so we will still be fighting inflation, but at the same time, we will provide a boost to the economy to reduce the risk of reaching a tipping point in the labour market.

Q: If there's any doubt about the need to move in October, might it be best to wait until December and cut by 50bp?

A: Decisions need to be made meeting by meeting. We will see what will happen in December, but there is no need to delay the decision in October. From what I’ve seen, the same kind of move now as in the past would be appropriate. We have regular meetings and if necessary, we are always able either to speed up or slow down.

Q: From a risk management point of view, maybe a particularly large move in October would make sense, because that way you ensure that things don't get too bad. And as you said, later on, you can slow down the pace if you decide that 50bp wasn’t really necessary.

A: There is no one single path to a sustained 2% inflation. But 25bp would now be much more appropriate. Let’s learn from what happened a year ago, when financial markets got carried away and were pricing a scenario inconsistent with our baseline scenario. That created lots of volatility in financial markets, which is bad for the economy. Therefore, a measured pace of monetary policy adjustment is the best approach. Of course, if the data worsen significantly and we see that we are moving to a different baseline scenario, then we will do what is necessary. But currently, although the data are somewhat worse than expected, we are still within the existing baseline scenario.

Q: What would have to happen between now and October 17 for a cut to be unlikely?

A: There are no major data releases between now and then, although revisions of past data can be very large, especially for small open economies. Of course, we take decisions based on the euro area, but just for example, until last Sunday, we thought that last year, the Latvian economy had shrunk by 0.3%. On Monday, we learned that in fact it grew by 1.7%. But things are volatile and there is no clear trend up or down, so my worry is that if the recovery is slow to come, then confidence may start to wane. So, in my view, supporting the economy would be appropriate. Also, we see that lending remains subdued. Yes, rates are coming down, but lending volumes are not picking up strongly yet. We see that households are saving more than expected and not consuming enough to drive the recovery.

Q: And are there some pieces of information coming out between now and October 17 that are particularly relevant?

A: We are not data point-dependent, we are data-dependent.

Q: Would you see a cut in October as making less likely a cut in December?

A: Let's not speculate on that. The direction of rates is very clear. That’s one thing. Point two is that rates are still in restrictive territory. Where is neutral territory? Nobody knows. We will learn step by step. But we can be quite confident that we still have at least a few cuts before we get close to neutral. Once we do, we should become much more cautious so as not to reignite inflation. But we are not in that position with current interest rates.

Q: And if there's a cut in October, would you want markets to understand it as merely bringing forward the date of a future cut so that the total amount of easing remains the same? Or could it actually lead to a lower terminal rate, meaning more easing in total?

A: We don't know where the terminal rate is. It is unobservable, and we don't know what shocks are going to occur. Uncertainty remains very high. So, visibility is still low and we have to go from meeting to meeting. If we see in October that we can cut rates – and I think we can – then we will do so. What we do in December, when we have a new set of projections extending into 2027, we'll decide then. For now, let's stick to the October meeting. I don't think that there is any need to frontload anything; we'll just take decisions meeting by meeting. By the way, this very clearly shows our flexibility. There have been stories that we would only cut when new forecasts are available, so on a quarterly basis. Of course, new forecasts allow a much more detailed analysis. But we also follow developments in the meantime, and if necessary, we can react at any meeting. And that is the nice thing about a gradual approach, moving step by step, guided by the data.

Q: How significant has the risk of undershooting inflation become?

A: A growing risk of this is natural, because we are approaching the target from above. Inflation was very high and policy tightening very sharp. We see that policy transmission has been strong. We also see that the sacrifice ratio for employment has been relatively low. It would be naive to expect us to smoothly float down to 2% and then hover precisely there. The world is uncertain, monetary policy has its lags, and there are many other moving parts, including base effects. So, the inflation rate will fluctuate around 2%. But the closer we get to 2%, the more these risks need to be taken into account. And if we see a risk of inflation sustainably falling below 2%, then we will act, because the target is symmetric. We should not intentionally undershoot.

Q: And is it possible that risks are on the downside now with regard to inflation?

A: I would not go that far, though let’s wait for our next analysis. But as for growth, we've been saying that risks are on the downside, and this is still so. This is the main reason for the possible rate cut in October. Unfortunately, geopolitics are not making life easier. The Middle East is still volatile and possibly explosive. Surprisingly, oil had come down quite significantly from the levels seen over the summer, but recently has rebounded somewhat. But it's much easier to think of negative rather than positive risks to growth.

Q: The PMIs have been weak lately, but they’ve been weak for a long time. What is the difference now?

A: The dynamics. If you look at the PMIs for industry, we’ve been below 50 for a long time already, but at least services were significantly above 50, and now we see services weakening towards 50.

Q: You mentioned that a year ago, market expectations were overblown. Are we in that situation again now, with markets expecting a cut at every meeting until the middle of next year?

A: I would say, “Let's be cautious.” I would be comfortable expecting continued cuts of the same magnitude, unless the economy is faring worse than expected. Of course, there is still high uncertainty. But markets should be cautious about whether they are still pricing the same baseline scenario as the central bank. Someone might be wrong; that's part of the deal. But of course, as soon as we see that the scenario has shifted, we will change it.

Q: You observed that, for now, the ECB has only cut interest rates in quarterly meetings…

A: But not by intention; it's simply the consequence of economic developments.

Q: Still, the ECB flagged the projection meetings, noting that there was more information then. But now that you’re going to cut in October, which is a non-projection meeting, should the ECB avoid such communication in the future?

A: At projection meetings, we have much richer grounds for a decision. But at the same time, we have always said that all meetings can and will be used to make decisions. And if you have very clear evidence between projection meetings that the economy has lost steam or monetary policy needs to be adjusted, you don’t pretend your hands are tied just because it’s not a projection meeting.

Q: In the longer term, how worried are you that we're going to get back the same low inflation, low growth environment that we had before?

A: There are many ways to answer this question. In terms of monetary policy, we will increasingly need to look at whether monetary policy is too tight, so that we do not inadvertently push inflation too far down below 2% and then struggle later to increase it. But at the end of the day, it's also a discussion about r*, and there are many other economic policies that have more influence on r*.

Q: The Draghi Report called for a major increase in investments to improve Europe’s competitivity. Does the ECB have anything to contribute here, given the positive effect on investment of lower borrowing costs?

A: The Governing Council has spoken out consistently about the need for structural reforms. This is of critical importance. But should we cut rates to support investment? I don't think that's the correct way to think about it. Think back to when we had negative rates. Did we see lots of productive investment then? No. So, productive investment is not driven predominantly by interest rates. Monetary policy creates a stable basis for incomes and the economy to grow. But other policies must do their job for these goals to be reached, starting with fiscal policy, but also including labour market policies and innovation policies, for example. The policy decisions are tough but necessary, so let's move on with this. Let's not keep waiting for monetary policy to intervene at times of crisis.

Q: Going back to the subject of an October rate cut, should the ECB try to get more bang for its buck by making it a so-called dovish cut?

A: Whether it’s a hawkish or dovish cut is ultimately a matter of how financial markets define it. If they perceive it as a hawkish cut, that's fine by me. But I think people are often not clear about what a dove is and what a hawk is. Is a hawk the one that moves quickly? I would say I'm a quick mover who is pragmatic and wants to move as soon as it’s appropriate to do so.

Q: So, no promises, not even a little indication to markets about what follows October?

A: We have given indications of our reaction function. We are giving indications of our inflation outlook. We are giving indications of our macro outlook. If it is all consistent, it should make sense. So far, I see it as still consistent. And the cut in October would be appropriate, in my view and based on the data that we've seen so far. If the markets want to call it a hawkish cut, fine by me.

Q: So, no reason for the data-driven, meeting-by-meeting approach to change, and everything should be left completely open.

A: I don't see a reason to change anything about a mechanism that is currently working well.

Q: Has the fact that the US Federal Reserve cut by 50bp to some extent motivated you or at least made it easier for you to back a cut in October.

A: Yes and no. The Fed did the cut because they saw it as appropriate for the economic situation. But the global economy is interlinked. So of course, it also affects us to some extent, via spillovers in terms of financing conditions, for example. But remember that the Fed moved after us. So, we take into account all the implications of what others do, but we do not blindly follow any central bank.

Q: With respect to the labour market, you used the expression “tipping point”. Is this something that we really have to worry about at this point?

A: Not yet, but we want to be careful to avoid this, because there is a risk of nonlinearities. If we see confidence in services easing, then demand for services will probably start to weaken. And if there is no recovery in industry, then, of course, at some point, companies may start to think it's too costly to hoard labour. And this can kick off a non-linear adjustment where things happen fast. We’re not seeing this at the moment, so I'm not saying that tipping point concerns are already materialising. But let's not let it get that far. A rate cut will still leave monetary policy restrictive enough to address services sector inflation, but at the same time, it will provides some support, so that households start to spend and, hopefully, corporates start to borrow to invest.