(Bloomberg) -- The European Central Bank mustn’t keep interest rates too high for too long, according to Governing Council member Martins Kazaks, who said weakness in the euro-zone economy is now his “single biggest concern.”
“We shouldn’t hold rates at high levels for longer than necessary — because otherwise we would do more damage than necessary to the economy and to citizens,” the Latvian official said in an interview at the International Monetary Fund annual meetings.
At the same, he highlighted that — despite inflation coming down “much faster than expected” — domestic price pressures are “somewhat sticky,” uncertainty is high and risks like the Middle East, energy prices and US elections persist.
Therefore, “it makes sense to go step by step,” he said in Washington.
The remarks come as views at the ECB over where to take borrowing costs begin to diverge. Last week’s third reduction in rates has prompted dovish officials to call for more rapid cuts, citing the steep retreat in inflation and the weaker economy. Their more hawkish colleagues, though, urge prudence and don’t want to rush easing.
Investors and economists are betting on a series of rate decreases in the months ahead and also see a good chance of a 50 basis-point move at the next meeting in December.
Kazaks said “the path for interest rates is clearly down” as long as the ECB’s baseline scenario holds and “unless something dramatic happens.” At 3.25% the deposit rate is “still very restrictive,” he said.
Policymakers have become more vocal about the need to lower borrowing costs to — or even beyond — a neutral level that neither stimulates nor restricts the economy. Most analysts and many officials see this level at 2%-2.25%.
“The economy is my single biggest concern,” Kazaks said. “Our mandate, of course, is inflation, but my worry is that if growth doesn’t resume, the labor hoarding can flip around in a non-linear way.”
The danger is that this leads to bigger job cuts and creates higher unemployment. There are “early signs of that,” Kazaks said. “I think in terms of policymaking, we have to be mindful of that.”
But there may be better news for the economy, with credit demand now rising among firms for the first time since 2022. “There are also some green shoots – in terms of the bank lending survey and with confidence among households improving.”
What’s more, consumer-price gains are below 2% for the first time since 2021.
“With inflation undershooting our estimates in the last couple of months and the economy somewhat weaker, it is quite likely that the uptick in inflation expected toward the end of the year will be less severe than anticipated and that we may reach our 2% target sustainably sooner than end of next year,” Kazaks said.
If that happens, “rates would need to adjust and be in line with that,” Kazaks said. “We need to be closer to neutral rates before we are de facto at target.”
He doesn’t see a “real risk” of undershooting 2% at the moment. “But we should be aware of this risk and the way to diminish this risk is to continue reducing interest rates.”
He worries, though, that there may be too much emphasis on ECB action.
“If other policy areas are late to come, then there’s a risk of monetary policy becoming the only game in town — that would not be good for our economies,” Kazaks said. “Monetary policy cannot be the cure for all our problems.”
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