(Reuters) – The European Central Bank must swiftly normalise interest rates as inflation could still go higher and policymakers should even consider frontloading rate hikes, Dutch central bank chief Klaas Knot said on Tuesday.
The ECB raised its deposit rate by 50 basis points to zero in July and a similar move was expected for September until recently, but a host of policymakers, including Knot, made the case for discussing a larger, 75 basis point increase as well.
“A swift normalization of interest rates is an essential first phase, and some front-loading should not be excluded,” Knot said in a speech. “The broadening and deepening of our inflation problem generates the need to act forcefully.”
At 8.9%, inflation is already more than four times the ECB’s 2% target and could exceed 10% in the coming months, raising the risk that even longer term expectations move higher as businesses and households start to doubt the ECB’s willingness or ability to control prices.
Knot himself argued that there were upside risks to inflation, including from higher food and energy prices, a weaker euro, copious budget spending and rising expectations.
A recession, increasingly considered the baseline given the loss of gas supplies, would weigh on price pressures but Knot argued that this alone would not be enough.
“Even if this slowdown were to materialize, this in itself is unlikely to bring inflation back to our objective over the medium term,” he said.
While it was uncertain where rate hikes should end, Knot argued that the ECB should just keep raising rates until the inflation outlook becomes consistent again with the ECB’s symmetric target.
As part of policy normalisation, the bank should also consider reducing its balance sheet after trillions of euros worth of bond purchases over the past decade.
“The size of the central bank’s balance sheet is and should become an important element of the normalization process as well, and I expect the issue of Asset Purchase Programme-reinvestments to feature more prominently in our discussions at a later point in the year,” Knot said.
(Reporting by Balazs Koranyi, Editing by William Maclean)
