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The European Central Bank’s battle against surging inflation after the pandemic has caused far less damage to the wider Eurozone economy than rate-setters anticipated, a veteran policymaker told the Financial Times.
Klaas Knot, whose second term as president of the Dutch central bank DNB ends at the end of June, said he has been “positively surprised” at the limited economic fallout from the ECB’s dramatic tightening of monetary policy from mid-2022.
“We would have been prepared to accept more economic pain [to battle inflation] but luckily we didn’t have to,” the longest-serving member of the ECB’s 26-member governing council said.
Knot, 58, who was one of the more hawkish voices among ECB policymakers, will leave the decision-making body after 14 years next week, when he will be replaced by DNB executive board member Olaf Sleijpen. However, he is considered as a possible contender to replace ECB president Christine Lagarde, whose term ends in 2027.
After years of negative interest rates, the ECB from mid-2022 jacked up borrowing costs 10 times within 14 months. Rates went from -0.5 per cent to 4 per cent to tackle annual inflation, which nearly hit 11 per cent. Economists at the time feared that the abrupt and unexpected change after an era of ultra-low monetary policy might have been followed by higher unemployment, a wave of corporate insolvencies and potentially a new government debt crisis.
Yet the Euro area managed to avoid both a recession and government bond market turmoil. Real GDP has edged up 2.6 per cent since mid-2022 while unemployment has fallen to fresh record lows.
Knot acknowledged that consumers suffered a “real and painful” loss of purchasing power in 2022 and 2023 due to the sharp rise in prices. But the subsequent tightening in monetary policy did much less damage to the labour market and economic growth “than we might have feared beforehand”, he said.
“I have been positively surprised that the cost of fighting inflation has been so low this time around compared to the last time when we had such an enormous bout of inflation during the 1970s,” he said.
Since June last year, the ECB has halved borrowing costs from 4 to 2 per cent while inflation has come down to close to the ECB’s medium-term 2 per cent target. Interest rates at their current level were neither stimulating economic activity nor holding it back, said Knot: “That’s a good place to be, regardless of what the future will bring.”
Asked about market expectations of one more quarter-point cut in rates by the end of the year, Knot said that possibility was “difficult for me to exclude”. But he added that it was anything but certain as inflation risks were currently “two-sided”. Policymakers needed time to see how the global trade war and oil prices would impact inflation and growth, he said.
“It may well be that the ECB has to hold rates for quite some time to come as long as you don’t know which way these shocks will actually play out on the medium-term outlook,” he said.
Knot, who also chaired the Financial Stability Board, which co-ordinates global regulation, said he saw no sign that the US might pull out of the body. US and European officials have clashed over the body’s focus on the financial risks of climate change and its scepticism about stablecoins and other crypto assets.
“Of course, there are differences of opinion between members on the relative weight that you should attach to the various risks,” said Knot, who will be succeeded as FSB chair in July by the Bank of England governor Andrew Bailey. But he stressed that the discussions have been “mature” and did not impede “the FSB from executing its mandate”.
