Klaas Knot, president of the Bank of Holland and of the Financial Stability Board, spoke this week to Corriere della Sera, El Mundo (Spain), Handelsblatt (Germany) and Les Echos (France). (Here the English version of the interview: English version)
Governor, industrial production in the euro area is declining and raw materials cost less than a year ago. Do you think inflation can remain high?
“There is a lot of uncertainty about this, but energy prices have spilled over into other parts of the consumer goods basket. There has been a widening of inflation. Underlying inflation is our main concern today and is still showing no signs of abating, especially in services. Indeed, manufacturing activity appears to be contracting. But for the moment we do not see a slowdown in services. Most services are labour-intensive and wage developments are one of the main upside risks to the inflation outlook. The peak in headline inflation is clearly past, but for underlying inflation we are not sure whether we have reached it yet. As monetary policy makers, we need to be confident that there is a significant decline in underlying inflation."
According to the vice president of the ECB De Guindos the monetary tightening is in the final phase. For Joachim Nagel, president of the Bundesbank, the increases should continue after the summer. Where do you see the highest point of rates?
“I don't know yet, we have to depend on the data. I think we will still need more rate hikes in June and July, new incoming data seems unlikely to change dramatically in the meantime. I am convinced that our analysis will indicate the need for at least two more 25 basis point hikes. But I'm totally open about what happens after the summer. It's too early to tell."
Are you confident that the euro area has avoided a recession?
«The effect of the monetary tightening has yet to come in full and this leads to uncertainty about growth prospects. In any case, growth in the euro area will not be very abundant. A period of low to moderate growth lies ahead. Then of course there is always the risk that, in the event of another shock, we could very quickly enter a recession. But that's not my baseline scenario. I believe we will have low growth in 2023 and maybe even in 2024».
Do you expect high rates in two, three or four years?
“I would describe what we are doing now as a slower and more protracted action. We went from 50 basis point rate hikes to 25 basis point hikes in May. There is a general understanding in the Governing Council of the ECB that even if we hit peak rates at some point not too far in time, we will probably need to stay there for a significant period. Market expectations of rate cuts are overly optimistic. Underlying inflation is more persistent than we expected. And we know historically that once it gets to wages and prices of services, those become very permanent components of price dynamics. Difficult to get the genie back into the bottle. I think once we hit peak rates, we'll have to stay there for a pretty significant amount of time."
Germany has entered a recession. Is it becoming a problem in Europe?
"I would not say. The economic structures of the countries of the euro area are different and there will always be particular shocks to each one. Germany has a couple of specific issues: dependence on the auto sector, part of which depends heavily on exports to China. Among other things, the automotive industry faces an important transition with the abandonment of combustion engines. And relations with China are more tense than before, with negative impacts on export opportunities. But I trust in the ability of political decision-makers to manage these challenges".
Are rate hikes likely to have destabilizing effects in Europe, not so much on banks as on insurance companies, private markets or pension funds?
“Life insurance and pension funds are naturally protected, because they also have long-term liabilities (not just long-term assets, ed). On the other hand, from a liquidity point of view, I am a little more concerned about investment funds, money market funds and the like. Some of these funds still offer the illusion of daily payouts, while locked into long-term investments: not just bonds, even commercial real estate. This absolutely requires vigilance. It requires strengthening liquidity management tools within these financial institutions. It is exactly the work program of the Financial Stability Board. It is one of our cornerstones and should also be put into practice in the euro area».
How worried are you about the evolution of the debt in Italy and Spain?
“Public debt has increased in the countries of the euro area in general. The phenomenon is more evident in some countries of the South. But there is also an intermediate group of countries, such as Belgium and France, where public debt has increased quite dramatically. It is understandable, given the shocks we have had to suffer and in which the budgetary policy has had to partially amortize. But now is the time to withdraw fiscal support and reduce the debt-to-GDP ratio. It is of the utmost importance. Governments face higher funding costs because we have to fight inflation. They will need to have higher primary balances to offset higher borrowing costs. This adjustment will have to happen and there is not an infinite amount of time available to do it. It will have to happen this year and next.'