By David Barwick – FRANKFURT (Econostream) – An early interest rate move by the European Central Bank would be warranted if inflation became entrenched and spread beyond energy into the rest of the economy, according to ECB Governing Council member Mārtiņš Kazāks.
In an interview with Econostream on Tuesday (transcript here), Kazāks, who heads Latvijas Banka, said, “If I saw signs that inflation was becoming entrenched and spreading across sectors, with meaningful second-round effects, then an early move would be warranted to contain it before those dynamics intensified.”
How companies react, along with inflation expectations, would be key, he indicated.
“I would pay close attention to corporate pricing behavior: if firms begin repricing aggressively, the risk of nonlinear effects rises,” he said. “Inflation expectations are also critical. If the tails of the distribution start to fatten, that is something we would need to address.”
Oil prices, if they remained near where they are now, would still exceed the technical assumptions of the ECB’s new projections, Kazāks noted.
“If they stabilize around current levels, they would still be somewhat above the baseline, which reflects market pricing at the time of the exercise,” he said. “That gives you some sense of the kind of policy response that could become relevant.”
At the same time, he said it was too early to say whether current market rates pricing would prove correct.
“Market expectations may be reasonable, but at this stage we simply do not know,” he said.
Kazāks also said a lone rate increase would be surprising.
“It is true that a single isolated hike would be somewhat unusual,” he said. “Ultimately, it depends on the size and persistence of the shock.”
“If the objective can be achieved with less tightening, then there is no reason to do more than necessary,” he said. “Still, if one hike alone were enough, that would amount to a lucky coincidence.”
On the inflation outlook, Kazāks said the reaction of core prices would be decisive.
“If core inflation also starts to move up, then it becomes much harder to look through the shock,” he said.
The ECB should remain ready to act at any time, he said: “So every meeting is live.”
Clear second-round effects were not yet apparent, but the risk was there and would depend in part on fiscal policy.
“What I see at this stage is the possibility of second-round effects, not clear evidence of them,” he said. “That is something we need to be attentive to.”
“The fiscal response will be critical here,” he said. “If governments resort to overly broad support measures, the likelihood of nonlinear effects rises substantially.”
