ECB needs more rate hikes and faster balance sheet cuts, Wunsch says

Pierre Wunsch, a Belgian policymaker, suggested that the European Central Bank accelerate its balance sheet reduction and stop reinvesting maturing debt in its largest asset buying plan to support interest rate hikes.

The ECB has raised rates at a record pace and reduced its balance sheet in hopes that higher borrowing costs will reduce demand and inflation.

“We need to do more on quantitative tightening,” Wunsch, a member of the ECB’s Governing Council, told Reuters on the sidelines of the IMF and World Bank spring meetings in Washington. “Even if we stop reinvestments this year, it will take years to run down the portfolio.”

Wunsch said the ECB’s 3.2 trillion euro Asset Purchase Programme had been successful in letting 15 billion euros of debt expire each month.

“The market has reacted very well, and our balance sheet is still too big,” he remarked.

Wunsch, one of the first to recognize Europe’s inflation crisis last year, also said the ECB needed to keep rising interest rates and the market’s estimate for another 75 basis points of hikes was “reasonable,” but expectations of a rate drop before the turn of the year were not.

“I think May will be about 25 or 50 basis points,” Wunsch added. “If there’s another upside surprise in core inflation and the (ECB’s quarterly) lending survey doesn’t look too bad, we might have to do 50,” he said. “If there is a positive surprise in core, then perhaps 25 is more appropriate.”

Markets predict the ECB to raise its 3% deposit rate to 3.75% by September, but then expect a reversal, contrary to the ECB’s promise that rates would peak and stay there.

“Given that wage dynamics will be incompatible with the 2% inflation target for years and real rates are still low, I don’t see any quick reversal of policy once we reach the terminal rate,” he added.

The euro zone’s main issue is that underlying inflation is still growing and defying expectations, showing that the ECB doesn’t completely comprehend price dynamics.

“What is really concerning is that in December we projected core inflation stabilising at 5% before its decline,” Wunsch remarked. “We’re now 5.7%, and within a few months the deviation from that December projection could be 1 percentage point.”

Wunsch said that core inflation may stay above 3% for a while, especially after the major energy price drops.