"No time for tinkering": Knot: ECB to crack down on inflation

Inflation in the euro area is at a record level and is picking up again in Germany.

"No time for tinkering": Knot: ECB to crack down on inflation

Inflation in the euro area is at a record level and is picking up again in Germany. The European Central Bank now wants to take decisive action against inflation. A rapid rise in interest rates is imminent.

According to Klaas Knot, the head of the Dutch central bank, the European Central Bank (ECB) should take vigorous action against the massive surge in inflation in the euro area. "There is no time for tinkering. We must vigorously tackle the still growing problem of persistently high inflation," Knot said at a roundtable organized by Danske Bank. A rapid increase in interest rates is an essential first phase. According to Knot, it should not be ruled out that interest rate hikes will be brought forward.

This procedure is often referred to by currency watchdogs as front-loading. From the point of view of the ECB Governing Council member, the euro central bank may have to raise interest rates above the so-called neutral level, at which the economy is neither fueled nor dampened, in order to fight inflation. Asked about his views on the ECB's likely next rate hike on Sept. 8, Knot signaled that he was leaning towards a very large 0.75 percentage point hike. But he is open to discussion, he added.

Several central bankers, including Knot, had recently spoken out in favor of discussing a corresponding rate hike in view of deteriorating inflation prospects. Estonia's central bank chief Madis Müller also joined on Tuesday. "I think 75 basis points should be among the options for September as the inflation outlook hasn't improved," Knots' ECB Council colleague said on the sidelines of a conference in Alpbach, Austria. "We shouldn't be too shy about taking monetary policy steps because inflation has been too high for too long and we are still well below the neutral interest rate," said Müller.

Central bankers currently put the neutral interest rate level at between one and two percent. Until recently, the capital markets were still expecting a step similar to that at the July meeting. At the time, the ECB had initiated the turnaround in interest rates and raised the key rates by 0.50 percentage points. The key interest rate is currently 0.50 percent. It was the first increase in eleven years. According to the statements made by several ECB central bankers, speculation on the stock exchanges has increased to an even bigger step.

How the decision will turn out in early September should depend in particular on the new inflation data for the euro zone in August, which are expected this Wednesday. In Germany, the largest economy in the currency area, the rate of inflation is on the rise again despite the fuel discount and 9-euro ticket: the inflation rate reached 7.9 percent in August after 7.5 percent in July. This is considered a bad omen for the fall, when the gas levy will impose further burdens on citizens.

Economists are therefore calling for the ECB to take a very strong interest rate hike on September 8th. "Hopefully the ECB will manage to make a big interest rate hike of 0.75 percentage points at its meeting next week," said Commerzbank chief economist Joerg Kraemer. Thomas Gitzel from VP Bank also believes that a big step is necessary. "Judging by the current inflation rate and what's still to come, the ECB should actually launch a jumbo rate hike," he said.

From Knot's point of view, the ECB should initially raise interest rates to a neutral level of between one and two percent this year. But he's not convinced that's enough to curb inflation, he said. The central bank may have to switch to a restrictive monetary policy. According to Knot, the latest indicators point to a slowdown in the economy. "However, even if this moderation were to materialise, it would probably not be enough to bring inflation back towards our medium-term target," he noted. In July, inflation in the euro area rose to a new record level of 8.9 percent. That is more than four times as high as the target of two percent inflation that the ECB is aiming for.

In Knot's view, the central bank should also consider reducing its balance sheet, which has been bloated by the trillion-dollar bond purchases of recent years. This could happen, for example, by the fact that the funds from expired bonds of the APP purchase program are no longer fully reinvested, he explained. But that will only happen gradually, he said. Talks about this could start in October or December.

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