Speaking at this year’s European Banking Congress, Bundesbank President Joachim Nagel repeated his call for a further increase in ECB key interest rates. “To ensure the return to price stability, long-term nominal and real interest rates must sufficiently increase,” he said. “On that note, I consider it a premature discussion whether we have already reached restrictive territory,” Mr Nagel continued, explaining that even after the rate hikes, the relevant policy rate is still in the expansionary range. The deposit rate currently stands at 1.5%. “If we don’t act decisively now, we run the risk of having to tighten monetary policy all the more later,” the Bundesbank President cautioned, noting that this would put even more strain on households, businesses and the financial system. This is why, in his opinion, it would be “wrong to hold back on further decisive steps for fear of a downturn”, he stressed. He believes that the ECB also needs to look at the Eurosystem’s high bond holdings. “In my view, we should start reducing the size of our bond holdings at the beginning of next year by no longer fully reinvesting all maturing bonds,” Mr Nagel explained, arguing that the additional tightening would help to bring inflation down and underline the ECB’s firm determination to bring inflation back to its target.

Lagarde and Knot also in favour of further interest rate steps

© Jose Poblete, dfv Euro Finance Group

Fellow Congress speaker Christine Lagarde, European Central Bank President, also argued in favour of further interest rate steps. She explained that the ECB may have to accept that the measures will place constraints on economic growth. “We expect to raise rates further,” Ms Lagarde said – and withdrawing accommodation may not be enough. Similar comments were made by Klaas Knot, member of the ECB Governing Council and President of De Nederlandsche Bank. As he put it, interest rates need to enter restrictive territory to address high inflation persistence in the euro area, because demand needs to be dampened. “Our response needs to be resolute,” Mr Knot told the audience at the Congress.

© Jose Poblete, dfv Euro Finance Group

The ECB Governing Council aims for 2% inflation over the medium term. In October, though, euro area consumer prices were 10.7% higher than in the same month a year earlier. The ECB started raising its key interest rates to combat high inflation in July. The next ECB meeting in which a decision on interest rates will be made will take place on 15 December.

Inflation shock will leave “scars”

In his speech, the Bundesbank President also explained how high inflation rates affect people’s inflation expectations over the long term. “The longer we live with high inflation rates, the more they are going to shape people’s lifetime experiences. And these new experiences may influence their expectations and decisions – even after inflation has fallen again,” he said. For example, East Germans expect higher inflation than West Germans – even decades after reunification. Citing a study on the topic, Mr Nagel described how this was attributable to there being no official inflation in East Germany, whereas people in West Germany were used to moderate price increases. The result of this was that, accordingly, the inflation shock following reunification shaped East Germans and West Germans differently. The “scars” that the current inflation shock would leave could lead to a transformed inflation setting, the Bundesbank President remarked. Given climate change, the energy transition, ageing societies and the reordering of globalisation, he continued, structural changes were to be expected in this area anyway. Overall, this could lead to higher trend inflation, but also to a more volatile inflation environment. In Mr Nagel’s words, central banks must prove in the current situation how determined they are to attain price stability.