Monday, November 28

ECB could start shrinking balance sheet once rates hit neutral, Knot says

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WASHINGTON — The European Central Bank should consider starting to shrink its oversized stock of assets once interest rates rise to a level that neither stimulates nor slows economic growth, Dutch Central Bank chief Klaas Knot said on Saturday.

The ECB has been raising rates quickly in recent months and most policymakers see the 0.75% deposit rate hitting this so-called neutral level, somewhere between 1.5% and 2% towards the end of the year.

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Knot did not specify an estimate for the neutral but said the rate should reach a range of plausible estimates.

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“Once we will have reached neutral territory with our policy rate, it makes sense to consider the roll-off of asset purchases by limiting reinvestments,” he said in a speech in Washington. “I do believe that we should move gradually here.”

Such a balance sheet run off, also known as quantitative tightening, should initially focus on the 3.3 trillion euros of debt held in the Asset Purchase Programme, Knot said, arguing for a different treatment of debt held in a smaller Pandemic Emergency Purchase Programme.

Rates hikes should not end at the neutral, however, and the ECB will likely have to enter a territory that brakes growth.

“I am increasingly convinced that we need to do more than just removing accommodation to fulfill our price stability mandate,” Knot said.

While Knot in the past has argued for a large, probably 75 basis point rate hike on Oct 27, he said that the pace of hikes should eventually slow down and the bank should move in smaller steps.

“I do not expect policy rate hikes to come to an abrupt end,” Knot said. “The farther we hike and the closer we get to restoring a credible prospect of inflation moving back to target, the smaller rate steps will likely become.” (Reporting by Balazs Koranyi; editing by Philippa Fletcher)