"I wouldn't have gone so far with the interest rate hikes"
Mr. Brzeski, ECB President Christine Lagarde once again tried in vain to dispel the markets' hopes of interest rate cuts in the spring at the press conference after the last monetary policy meeting. Why is she not succeeding?
It is difficult to dissuade the financial markets from a chosen path, it takes time. What's more, Lagarde can't find convincing language. When asked by a journalist whether she can refute that the ECB will cut interest rates six times in 2024, as the markets expect, she did not choose clear words but instead went into hiding in her communication.
When do you expect the ECB to cut interest rates for the first time?
We still expect the first rate cut in June. Thursday's meeting confirmed our view that the ECB considers this to be a good time.
Do I hear you saying that you would prefer an earlier easing?
We are more pessimistic than the ECB about economic growth in the eurozone. Our forecast is 0.4% for the coming year, and the ECB's is 0.8%. That's why I wouldn't have gone so far with the interest rate hikes and would have stopped 50 basis points earlier. Now I deem an initial rate cut one or two months before June appropriate.
You think the economic forecast is too optimistic. What about the inflation?
We don't differ there. I also expect 2% to 3% in 2024 and around 2% in 2025.
In your podcast, you said that the ECB's communication regarding forward guidance will be important when it comes to cutting interest rates. What advice do you have for the central bank?
It should clearly communicate what its criteria for interest rate cuts are. At the moment, observers see this as more of a stab in the dark. What exactly does the ECB need to initiate interest rate cuts? For example, how exactly must the wage data or long-term inflation forecasts turn out to be a sign for the ECB to ease.
You believe inflation would have fallen sharply in 2023, even without the ECB's interest rate hikes. Why do you come to this conclusion?
The decline in inflation so far is hardly a success of the ECB. It is mainly due to base effects that would have occurred even without interest rate hikes. The full impact of the interest rate hikes on inflation is yet to materialise.
In other words, you are not yet seeing the effects of lower lending, which are clearly a consequence of higher interest rates, in the inflation data.
Exactly, they are still impacting and will lead to inflation falling back to around 2% by 2025.
Even if one were to agree with your assessment that inflation would have fallen this year anyway, the ECB has to raise interest rates significantly when inflation peaks in double figures.
Definitely, simply because of the psychological effects of monetary policy, there was no other option. Otherwise, it would no longer have any credibility as far as the mandate of price stability is concerned. The ECB did the right thing by raising interest rates. Whether the extent and timing of the interest rate hikes was right is debatable.
Another topic of the interest rate decision was the changes to the PEPP bond purchase programme. Is the reduction in reinvestments from July 2024 on the right step for you?
Yes, the normalisation of the ECB's balance sheet is the right thing to do. However, the timing of the announcement is strange and leaves room for speculation.
And what are your speculations regarding the ECB's balance sheet?
Two possibilities come to mind. It could be horse-trading for the hawks. The ECB increases the pace of balance sheet reduction, but the doves get their way on the timing of the first interest rate cut. Or members of the Council were in favour of another rate hike in December, and because they couldn't get their way, they got the changes to PEPP.
Next year, a possible increase in the minimum reserve for commercial banks will become an issue at the ECB. What do you expect?
This is likely to be decided at the review of the ECB framework, which will probably be in the spring. I expect an increase from 1 to 2%. That is the value that the minimum reserve had before all the crises.
Let's take a look across the Atlantic. In its interest rate decision on Wednesday, the Fed was less restrictive than the ECB on Thursday. What are the reasons for this?
The Fed is preparing for a slowdown in the economy. The situation on the labour market is deteriorating and the country is heading for a recession in the first half of 2024.
If the Fed were to cut interest rates early next year due to economic developments, what impact would this have on the ECB?
These prospects are already causing capital market interest rates to fall not only in the US, but worldwide. From the ECB's perspective, this unintended easing is increasing inflationary pressure in the eurozone. At the same time, interest rate cuts by the Fed are weakening the dollar against the euro, which is hampering growth in the eurozone. So, there are two opposing developments. There is no automatism for how an earlier rate cut by the Fed will influence the ECB's monetary policy.
Meet the person
Carsten Brzeski has been Chief Economist for Germany and Austria at ING since March 2013. He regularly analyses economic and political developments in Germany and Europe, including the ECB's monetary policy.
