Published: 25.09.2023

By Luke Heighton

The European Central Bank needs to tame inflation in one attempt, without pausing too early then having to hike more later, Bank of Latvia governor Martins Kazaks told MNI, adding that higher energy costs and real income growth still pose upside risks to prices despite an increased chance of getting to the 2% target in 2025 following September’s rates increase.

September’s “very appropriate” 25-basis-point hike may allow for a pause in October, with strong evidence monetary policy is working and considerable tightening in the pipeline, Kazaks said in an interview. But monetary policy decisions will depend on incoming data and rates will be set at sufficient levels for as long as necessary to bring inflation back to target.

“We should deal with inflation in one attempt. We should not allow ourselves to step out too early and risk needing to do more later,” he said, sounding a more cautious note than his Lithuanian counterpart Gediminas Simkus, though he noted the positive contribution of the hike in the deposit rate to 4.0%.

“The rate increase helps to narrow the inflation forecast so that we really are put on the path, in a more solid way, to reach 2% in the second half of 2025. I wouldn't like it to drag into 2026.”

Too early to talk about cuts

It will only be possible to consider a rate cut once inflation is projected below target and pandemic reinvestment programmes have ended, he said.

“In my view, we should start cutting the rates when we see in our outlook that inflation forecasts start to significantly and consistently undershoot 2%. If we just see inflation sliding down towards 2% then I do not see a reason for us to start cutting rates, because then we will push inflation back up again.”

Wage increases have not yet clearly peaked, Kazaks said, though he noted some evidence of profit margins falling as firms absorb higher unit labour costs.

“There is real income growth, and there are a few countries in the euro area where inflation is already lower than wage growth. That is exactly the reason why softening of corporate profit margins would be helpful, because of course there is going to be a recovery.”

Other risks come from energy markets.

“The recent oil price increase and what we've seen in terms of communication and actions from the oil-supplying countries, that is not a transitory thing; it is a structural thing, most likely with a much longer lasting impact. This adds to the inflation risks,” Kazaks said.


The ECB’s Governing Council did not discuss the future of its asset purchase or pandemic emergency purchase programmes when it met last week, Kazaks said, though he added that this will be among several major issues to be considered in the coming months.

“One is the operational framework, and of course we have the asset purchase programmes. In my view, what will be important to consider is that before we start cutting rates we will need our reinvestment programmes to have ended,” he said.

“We know that we must do it in a gradual way because we do not want to cause financial instability problems - it has to happen step by step - and this will need to be discussed. As the president said, we did not discuss these things at all at the last meeting, but they will be on the table at some point soon.”

Having opted in June to set the remuneration of minimum reserves at 0%, the Governing Council is unlikely to make any additional adjustment any time soon, Kazaks said.

However, excess liquidity “is an issue, and it will need to be removed,” he said. “One possibility is to increase the reserve requirement, and this would reduce the redistribution towards banks. But it has to happen gradually, so that it does not cause financial instability problems.”

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