VIENNA – European Central Bank Governing Council member Robert Holzmann has a clear message: Be prepared to say bye-bye to negative interest rates in the eurozone.
To gain control over inflation, the ECB should raise interest rates three times this year before hitting 1.5 percent or higher in 2023 if the price surge persists, Holzmann told POLITICO at his Vienna office.
“As inflation has been higher than we had expected a couple of months ago, I think three hikes this year will be possible,” said Holzmann, who also heads Austria’s central bank. That increase “would allow us to move into 2023 with an already positive deposit rate.”
The ECB’s deposit rate currently stands at minus 0.5 percent, which means three 25-basis-point hikes would take it to 0.25 percent.
But that tightening may well not be enough, in his eyes. He expects that further hikes towards the so-called natural rate — an estimate of where monetary policy neither increases nor constrains growth — will follow. He sees this rate around 1.5 percent.
“We can use the information we have by the end of the year to determine with what speed we have to move from there and beyond,” Holzmann said. “If the inflation rate moves towards 3 or below 3 percent, this would allow a smoother increase. If it remains at 5 percent, then … we may need to move faster beyond the 1.5 percent equilibrium interest rate next year.”
While ECB President Christine Lagarde in December still deemed interest rate hikes in 2022 “very unlikely,” repeated upside surprises in prices have prompted several policymakers, including Lagarde, to advocate for a lift-off this summer. In April, eurozone inflation surged to a record high of 7.5 percent, more than three times the ECB’s 2 percent target.
These readings mean “it’s very important to start with the hiking as soon as possible,” said Holzmann, a policy hawk. But he also conceded that a majority of policymakers wouldn’t sign off on a rate hike in June. Instead, he said, they may opt in June to essentially pre-commit to the first ECB interest rate hike in over a decade for July.
“In June, we’ll have the latest data and forecasts available,” he said. “That’s the moment when we can reflect on what the outlook is for the next three years or so. This should allow us to make a decision in June for July.”
mind the dots
In addition to hiking rates, Holzmann wants the Governing Council to use those meetings to discuss the future of the central bank’s forward guidance. Its current guidance, which is complex and gives three conditions for rate hikes, will have outlived itself.
The challenge is the unusual nature of today’s economic environment, with inflation racing ahead of target and the outlook shrouded in uncertainty due to the Ukraine war and Chinese lockdowns. Policymakers may be well advised to stay clear of specific guidance and instead take a page from the US Federal Reserve’s “dot plot.”
This quarterly chart, which summarizes the outlook for the main interest rate, maps out dots to represent the views of Fed policymakers on the rate’s target range.
It would “make a lot of sense” if the ECB followed suit, Holzmann argued.
“I was always in favor of using the [natural] interest rate,” he said. “It’s flexible, but it gives the financial market a good orientation [and] still allows us to deviate from it as new information comes to the table without putting all decisions into question.”
The ECB has been drawing flak from both sides — with some saying it’s not moving quickly enough against inflation and others warning that tightening will push the eurozone back into recession.
But Holzmann sees the central bank as charting the right path to steer the eurozone between these two risks. He also remains optimistic that the war won’t derail the region’s recovery, even though it’ll hurt growth.
“Looking at the economic development, I don’t see a recession now,” he said. “Definitely the war in Ukraine has weakened the outlook … will not get the great upswing we had foreseen from the first quarter onwards. But that’s not a recession yet.”
Still, with high inflation and low rates, “given where interest rates are in real terms, we’re not stepping on the brake, but we are merely taking some pressure off the gas pedal,” he explained.
At the same time, he saw no reason for the ECB to follow the Fed’s lead and embark on bolder hikes of 50 basis points.
“The US has currently a higher inflation rate than the euro area. But perhaps more importantly, in the US core inflation is much higher than in Europe, and there’s more pressure in the labor market than in Europe,” he said. “In the US, there was a great need to act.”
Sporting euro-themed cufflinks, Holzmann suggested that the ECB may also keep markets guessing on the details of a potential policy tool to limit government bond spreads.
These spreads — which represent the premium that other eurozone governments must pay beyond the risk-free German 10-year bond — have recently emerged on rising yields in the eurozone’s most heavily indebted countries.
Investors fear that an ECB rate hike could make those debt levels — which spiraled during the pandemic — unsustainable.
Lagarde evoked in March the possibility of creating new tools to address this risk, and much speculation has followed in the absence of official elaboration.
“Whether or to what extent the details become public, I don’t know,” said Holzmann. “We haven’t talked about it. But financial markets should know that we might have it and it would be used if needed.”
The ECB will be up to the task, I insisted.
“From the outside, the Governing Council looks like a Roman arena,” he said. “But it’s more like a French sport fencing club. So I’m optimistic that we’ll be able to come up with the right answers.”
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