Germany’s central bank boss said the eurozone must be “stubborn” and keep raising borrowing costs to tackle inflation, as rate-setters on both sides of the Atlantic wrestle with the recent turmoil in the financial sector.
“Our fight against inflation is not over,” Joachim Nagel, Bundesbank president, told the Financial Times after he and other members of the European Central Bank’s governing council stuck to plans to increase interest rates by half a percentage point last week.
He was speaking ahead of the US Federal Reserve’s own rate-setting decision on Wednesday.
“There’s certainly no mistaking that price pressures are strong and broad-based across the economy,” Nagel said of the eurozone. “If we are to tame this stubborn inflation, we will have to be even more stubborn.”
The Fed is set to decide whether to continue raising interest rates, despite the collapse of US lenders Silicon Valley Bank and Signature. Analysts largely expect it to raise US borrowing costs by a quarter point.
Following the rescue-takeover of Credit Suisse on Sunday, Nagel said it was possible banks would become “more cautious” in lending. However, he added that it was too early to draw the conclusion that the region was heading for a credit crunch that would choke demand.
Nagel, who became Bundesbank president at the start of last year, downplayed the risk of contagion to the eurozone’s “resilient” banking system. “We are not facing a repeat of the financial crisis we saw in 2008,” he said. “We can manage this.”
Nagel displayed little sympathy for owners of SFr16bn ($17bn) of additional tier 1 (AT1) bonds in Credit Suisse, which were wiped out by Swiss authorities as part of the UBS rescue-takeover.
“Those who profit from opportunities should also take their share when risks materialise,” he said. “This was one of the takeaways from the global financial crisis.” But he confirmed that the eurozone would not follow the Swiss decision to bail in AT1s before a bank’s equity was wiped out.
Markets increasingly expect the ECB to pause its rate increases in May as financial conditions worsen.
However, Nagel said eurozone inflation had to drop “significantly and sustainably” from 8.5 per cent — more than four times the ECB’s 2 per cent target — before the bank would stop raising borrowing costs. Core inflation, which excludes energy and food prices, would also have to “decline sufficiently” after it hit a record of 5.6 per cent last month, he said.
“There’s still some way to go, but we are approaching restrictive territory,” he said, adding that once the ECB stopped raising rates it would then have to resist calls to cut them. Doing so would enable “inflation to flare up again”, as it did after the oil supply shocks of the 1970s.
Nagel is determined to maintain the German institution’s traditional “hawkish” stance. As the biggest shareholder in the ECB, the Bundesbank has an important influence on policy, though Nagel’s predecessor, Jens Weidmann, was often isolated in his resistance to more dovish monetary policy.
Nagel will visit the UK this week, including the House of Lords where he will make the first appearance by a Bundesbank president since Hans Tietmeyer in 1998.
He maintained a bullish outlook for the German and eurozone economies, saying: “I still envision a soft landing.”
His optimism on growth — and anxiety over inflation — was largely down to the eurozone’s “extraordinarily robust” labour market. Unemployment remains at record lows despite the ECB raising interest rates by an unprecedented 3.5 percentage points since last summer.
“This is a very exceptional cycle,” he said, adding that raising rates in the past had led to significant job losses.
Another difference was that the banking system remains awash with €4tn of excess liquidity, stemming from years of vast bond purchases and ultra-cheap lending by the ECB.
The bank this month started to shrink its bond holdings by not replacing €15bn of the securities that mature each month in its €3.2tn asset purchase programme.
But Nagel, whose first job at the Bundesbank involved calculating excess liquidity levels, wanted to go faster. “We should do more,” he said, when the council reviews the strategy in July.
He added that “at a later stage” the ECB could also consider shrinking a separate €1.7tn pandemic emergency purchase programme, launched in 2020 to counter the fallout of the Covid-19 pandemic.
While he praised ECB president Christine Lagarde’s ability to “bring people with different views together”, the consensus on the ECB council could soon be tested. “It’s when the going gets tough that you find out how good a team really is,” he said.