# ECB must swiftly normalise rates; neutral may not be enough, Knot says
Author:  Pal Sinha, Barnali 
Author URL: https://financedigest.com/author/pal-sinha-barnali
Published: 2022-08-30
Category: NEWS
Category URL: https://financedigest.com/category/news
Meta Title: European Central Bank Urged to Swiftly Normalize Interest
Meta Description: ECB's Knot stresses the urgency of raising rates due to soaring inflation, hinting at a possible 75 basis point increase to counter rising price pressures.
URL: https://financedigest.com/ecb-must-swiftly-normalise-rates-neutral-may-not-be-enough-knot-sayshtml

(Reuters) -The European Central Bank must swiftly normalise interest rates as inflation could still go higher and lifting rates to the neutral level, which neither stimulates nor slows growth, may not be enough, Dutch central bank chief Klaas Knot said on Tuesday.

The ECB raised its deposit rate by 50 basis points to zero in July and a similar move was expected for September until recently, but a host of policymakers, including Knot, made the case for discussing a larger, 75 basis point increase as well.

“A swift normalization of interest rates is an essential first phase, and some front-loading should not be excluded,” Knot told a Danske Bank event. The broadening and deepening of our [inflation problem generates the need to act](https://www.financedigest.com/u-s-eu-to-address-inflation-reduction-act-fears-constructively-draft.html "U.S., EU to address Inflation Reduction Act fears constructively -draft") forcefully.

When asked about his preference for the move, Knot hinted that he was [leaning towards 75 basis points](https://www.financedigest.com/fed-officials-still-leaning-to-75-basis-point-rate-hike-in-july.html "Fed officials still leaning to 75-basis-point rate hike in July") but still wanted to review data and discuss with colleagues.

In the first step, the bank should get rates back to the neutral [level – somewhere between 1% and 2% – this year](https://www.financedigest.com/2016-must-be-the-year-of-board-level-transparency-and-good-governance.html "2016 must be the year of board level transparency and good governance") but Knot said he was “not convinced” that this will be enough and restrictive policy may be needed.

At 8.9%, inflation is already more than four times the [ECB’s 2% target and could exceed 10% in the coming months, raising the risk that even longer term expectations move higher as businesses and households start to doubt the ECB’s willingness or ability to control prices](https://www.financedigest.com/explainer-oil-price-surge-changes-ecb-narrative-only-at-the-margins.html "Explainer-Oil price surge changes ECB narrative only at the margins").

Knot himself argued that there were upside risks to inflation, including from [higher food and energy prices](https://www.financedigest.com/vhs-tapes-selling-for-46000-higher-than-original-price.html "VHS tapes selling for 46,000% higher than original price"), a weaker euro, copious budget spending and rising expectations.

A recession, increasingly considered the baseline given the loss of gas supplies, would [weigh on price](https://www.financedigest.com/oil-prices-rise-on-u-s-drawdown-chinese-fears-weigh.html "Oil prices rise on U.S. drawdown, Chinese fears weigh") pressures but Knot argued that this alone would not be enough.

One issue is that given the scarcity of labour, firms are likely to “hoard” labour in the initial phase of a downturn as this would be less costly than [struggling to find workers](https://www.financedigest.com/almost-half-of-companies-struggle-to-find-skilled-workers.html "Almost half of companies struggle to find skilled workers") later.

Even if this slowdown were to materialize, this in itself is unlikely to [bring inflation back](https://www.financedigest.com/trump-charges-bring-new-york-zombie-case-back-to-life.html "Trump charges bring New York ‘zombie case’ back to life") to our objective over the medium term,” he said.

While it was uncertain where rate hikes should end, Knot argued that the ECB should just keep raising [rates until the inflation outlook](https://www.financedigest.com/yen-sinks-as-rates-outlook-diverges-nz-dollar-tumbles.html "Yen sinks as rates outlook diverges; NZ dollar tumbles") becomes consistent again with the ECB’s symmetric target.

As part of policy normalisation, the bank should also consider reducing its balance sheet after [trillions of euros](https://www.financedigest.com/european-governments-spend-half-a-trillion-euros-on-energy-crisis-report.html "European governments spend half a trillion euros on energy crisis – report") worth of bond purchases over the past decade.

A reduction in the bank’s balance sheet could [come from the less than full reinvestment of funds maturing in the recently discontinued Asset](https://www.financedigest.com/analysis-watch-out-risk-assets-the-rout-in-bonds-is-coming-your-way.html "Analysis-Watch out risk assets, the rout in bonds is coming your way") Purchase Programme but this would be “very gradual.

Talks over a [balance sheet](https://www.financedigest.com/ecb-policymakers-back-jumbo-rate-hike-differ-on-balance-sheet-cut.html "ECB policymakers back jumbo rate hike, differ on balance sheet cut") reduction could start in October or December, Knot said.

(Reporting by Balazs Koranyi, Editing by William Maclean)


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