“Interest rates must continue to rise – and significantly so”

Bundesbank boss Joachim Nagel

“We will prevent this high inflation from becoming entrenched.”

(Photo: dpa)

Frankfurt According to Bundesbank President Joachim Nagel, the ECB must continue to raise interest rates sharply in the fight against record inflation. “If there is ten percent inflation, but only 1.25 percent interest, then the need for action is clear to me,” Nagel told the “Süddeutsche Zeitung” in an interview published on Friday. “Yes, interest rates must continue to rise – and significantly so,” he added.

Inflation in the euro area had climbed to ten percent in September – the highest level since the euro was created. The key interest rate in the euro zone is currently 1.25 percent.

Initially, inflation was largely driven from outside, Nagel said. But it now affects a large part of the shopping cart. “We must therefore be more persistent than inflation and act decisively,” he said. “We will prevent this high inflation from becoming entrenched.” This requires sufficiently strong and rapid reactions. “Clear signals must come from the next meetings of the Governing Council,” he said.

At its September meeting, the European Central Bank (ECB) raised its three key rates by 0.75 percentage points in an unusual XXL step. Most recently, more and more ECB monetary watchdogs had spoken out in favor of another mega rate hike at the upcoming interest rate meeting on October 27 because of the ongoing surge in inflation. The ECB is aiming for two percent inflation in the medium term. The euro central bank is currently very far from that.

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There is an energy price shock, the effects of which the central bank cannot change much in the short term. However, monetary policy can prevent it from leapfrogging and broadening. “In this way we are cracking the inflation dynamic and bringing the price development to our medium-term target. We have the instruments for this, especially interest rate hikes.”

Nagel: Reduce bond holdings

Nagel also spoke out in favor of the ECB also addressing the issue of reducing the central bank’s balance sheet, which has been bloated by years of bond purchases. “In the long term, the Eurosystem will also have to reduce its bond holdings,” he said. However, Nagel did not name a time for this.

The ECB had raised the issue at its meeting in Cyprus, as Nagel’s ECB Council colleague Peter Kazimir announced on Twitter on Thursday. Balance sheet reduction by reducing bond holdings is known in the industry as “quantitative tightening” (QT).

So far, however, the ECB has held out the prospect of replacing expiring bonds from its APP purchase program with new bonds for a longer period of time, even after the first interest rate hike. In the PEPP bond purchase program, expiring bonds are to be replaced by at least the end of 2024.

Nagel expects that as a result of the Ukraine war, the German economy will only grow between 1.3 and 1.5 percent this year. “In 2023 the development will be flat,” he added. “Yes, maybe a zero or a slight drop,” he said.

Nagel also confirmed earlier forecasts that inflation in Germany will rise to over eight percent this year. For the year 2023, Nagel considers a six before the decimal point to be realistic.

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