VIENNA – Robert Holzmann, Member of the Governing Council of the European Central Bank, has a clear message: Be prepared to say goodbye to negative interest rates in the euro area.
To gain control of inflation, the ECB should raise interest rates three times this year before reaching 1.5 percent or higher in 2023, if price increases persist, Holzmann told POLITICO in his Vienna office.
“Given that inflation was higher than we expected a few months ago, I think there may be three increases this year,” said Holzmann, who also heads Austria’s central bank. This increase “would allow us to move to 2023 with an already positive deposit rate”.
The ECB’s deposit rate is currently at minus 0.5 percent, which means that three increases of 25 basis points would push it to 0.25 percent.
But that tightening may not be enough in his eyes. He expects further increases towards the so-called natural rate – an estimate of where monetary policy will neither support nor limit growth – to follow. He sees this rate at around 1.5 percent.
“We can use the information we have by the end of the year to determine how fast we need to move from there and on,” Holzmann said. “If the inflation rate moves towards 3 or below 3 percent, it would allow a smoother increase. If it stays at 5 percent, then … we may have to move faster next year at 1.5 percent of the equilibrium interest rate.”
While ECB President Christine Lagarde still considered an increase in interest rates in 2022 “very unlikely” in December, repeated surprises in the form of rising prices have led several policy makers, including Lagarde, to push for a slowdown this summer. In April, inflation in the euro area jumped to a record 7.5 percent, more than three times the ECB’s 2% target.
These data mean that “it is very important to start hiking as soon as possible,” said Holzmann, a political hawk. But he also admitted that most politicians will not sign the rate hike in June. Instead, he said, they could decide in June to make a substantial commitment in advance to the first increase in ECB interest rates in more than a decade in July.
“We will have the latest data and forecasts in June,” he said. “This is the moment when we can think about the outlook for the next three years or so. That should allow us to decide in June and July.”
Watch out for the dots
In addition to raising rates, Holzmann wants the Governing Council to use the talks to discuss the future of future central bank guidelines. Its current guidelines, which are complex and provide three conditions for raising rates, will survive on their own.
The challenge is the unusual nature of today’s economic environment, where inflation is ahead of the target and the outlook is shrouded in uncertainty due to the war in Ukraine and China’s quarantine measures. Policy makers may well be advised to avoid specific guidelines and instead take a page from the US central bank’s “dot plot”.
This quarterly chart, which summarizes the key interest rate outlook, maps dots that represent Fed policy views on target rates.
“It would make a lot of sense” for the ECB to follow suit. Holzmann argued.
“I have always been for use [natural] interest rate, “he said.” It is flexible, but it provides the financial market with good orientation [and] it still allows us to deviate from when new information comes to the table without questioning all decisions. “
The ECB is attracting flak from both sides – some say it is not moving fast enough and others warn that the tightening will drive the eurozone back into recession.
However, Holzmann sees that the central bank is outlining the right way to manage the eurozone between the two risks. He also remains optimistic that wars will not derail the region’s recovery, even if it hurts growth.
“When I look at economic developments, I don’t see a recession now,” he said. “The war in Ukraine has definitely weakened the outlook … it will not see the big rise we expected from the first quarter onwards. But this is not a recession yet.”
Still, with high inflation and low rates, “given that interest rates are in real terms, we’re not going to step on the brake, we’re just going to step on the accelerator,” he explained.
At the same time, he saw no reason for the ECB to follow the Fed’s example and embark on bolder increases of 50 basis points.
“The US currently has higher inflation than the eurozone. But perhaps more importantly, core inflation in the US is much higher than in Europe and there is more pressure on the labor market than in Europe,” he said. “There was a great need for action in the United States.”
Holzmann suggested with sports cufflinks on the euro that the ECB could also leave markets to speculate on the details of a potential policy instrument to limit government bond spreads.
These spreads – which represent a premium that other eurozone governments have to pay over and above the risk-free German 10-year bond – have recently risen sharply due to rising yields in the eurozone’s most indebted countries.
Investors fear that raising ECB rates could make these debt levels – which spiraled during the pandemic – unsustainable.
Lagarde evoked the possibility of creating new tools to address this risk in March, and much speculation ensued due to a lack of official clarification.
“I don’t know if or to what extent the details will be made public,” Holzmann said. “We haven’t talked about it. But the financial markets should know that we can have it and that it would be used if necessary.”
The ECB will take on the task, he insisted.
“From the outside, the Board of Governors looks like a Roman arena,” he said. “But it’s more like a French sports fencing club. So I’m optimistic we’ll be able to come up with the right answers.”
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