ECB Will Act If Inflation Outlook Picks Up, Kazaks Says

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No one should be in any doubt that the European Central Bank stands ready to act if the inflation outlook strengthens, according to Governing Council member Martins Kazaks.

While the ECB sees consumer-price growth slipping below its 2% goal as supply-chain snarls are resolved and soaring energy costs ease, it must stay vigilant amid the persistent threat from Covid-19 and the elevated economic uncertainty, the Latvian central bank chief said.

“Don't be misguided that we won't raise rates, or that we won't cut the support if necessary,” Kazaks said Tuesday in an interview. “Of course we'll do our job.”

Speaking about the need to be able to adapt, he said “flexibility is the name of the game.”

The comments follow the ECB's decision last month to chart a course out of emergency stimulus measures enacted as the pandemic struck in 2020 -- despite resurgent cases of Covid-19 since the emergence of the omicron variant.

But while bond-buying will be gradually phased out, President Christine Lagarde has reiterated that an increase in interest rates in 2022 is unlikely. Investors aren't quite so sure, with money markets betting on a 10 basis-point hike by year-end and another by March 2023.

On Wednesday, Italian 10-year yields held two basis points higher at 1.23%, close to a two-month high, while their German counterparts remained one basis point lower at minus 0.09%.

Data due Friday are set to show record euro-area inflation slowed a little last month, to 4.8%. Bank of France Governor Francois Villeroy de Galhau said Tuesday that surging prices are close to their peak after French numbers provided the first signs of stabilization. A day later, however, Italian inflation hit its highest level in more than a decade.

The ECB forecasts prices rising 3.2% on average this year, and 1.8% in 2023 and 2024. But Kazaks isn't alone in warning of possible upside risks to that outlook. 

On the more hawkish side, Belgium's Pierre Wunsch has even said the projections show the ECB is “essentially at target” and that it risks falling behind international peers in confronting soaring prices.

No Market Surprise

The divergent policy trajectories were on view in December as the Bank of England surprised investors with a rate increase and the U.S. Federal Reserve accelerated its departure from crisis settings.

Due to the elevated uncertainty, Kazaks said he agrees with the ECB's current price outlook.

“We should take it step by step,” he said. “We'll have another forecast in March, we'll have another in June, and then we'll see more how things develop with inflation.”

Winding down bond-buying by year-end and raising interest rates in early 2023 -- an idea floated by Dutch Governing Council member Klaas Knot -- is a “possible scenario,” according to Kazaks.

At the same time, the ECB should avoid “rocking the boat.”

“We shouldn't surprise the markets and catch markets unaware of what's going on,” he said. “The step-by-step approach is very important.”

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