Klaas Knot, president of the Bank of Holland and of the Financial Stability Board, spoke this week with Corriere della Sera, El Mundo (Spain), Handelsblatt (Germany) and Les Echos (France). (Here the English version of the interview: English version)

Governor, industrial production in the euro area is declining and raw material costs are less than a year ago. Do you think inflation can stay high?
“There is a lot of uncertainty about that, but energy prices have spread to other parts of the basket of consumer goods. There is an increase in inflation. Underlying inflation is our main concern today and still shows no sign of abating, especially in the services sector. Indeed, manufacturing activity appears to be declining. But for the time being, we don’t see any delay in services. Most services are labour-intensive and wage developments represent one of the main upside risks to the inflation outlook. The peak in headline inflation is clearly over, but we are not sure whether we have reached it yet for underlying inflation. As monetary policymakers, we need to be confident that underlying inflation will come down significantly.”

According to ECB Vice President De Guindos, monetary tightening is in its final phase. For Joachim Nagel, president of the Bundesbank, the increases should continue after the summer. Where do you see the highest point of the rates?
“I don’t know yet, we have to go by the data. I think we will need even more rate hikes in June and July, new incoming data doesn’t seem likely to change drastically in the meantime. I am confident that our analysis will indicate that at least two more 25 basis point increases are needed. But I’m completely open about what happens after the summer. It’s too early to say.”

Are you convinced that the eurozone has avoided a recession?
“The effect of monetary tightening is still being felt in full, leading to uncertainty about growth prospects. In any case, growth in the euro area will not be very abundant. A period of low to moderate growth is ahead. Then of course there is always the risk that we will very quickly end up in a recession in the event of a subsequent shock. But that’s not my base case scenario. I think we will have low growth in 2023 and maybe even 2024.”

Do you expect high rates in two, three or four years?
“I would describe what we are doing now as a slower and more sustained action. In May, we went from rate hikes of 50 basis points to hikes of 25 basis points. There is general agreement within the Governing Council of the ECB that even if we do not peak too far in time at some point, we will probably have to stay there for quite some time. Market expectations of interest rate cuts are too optimistic. Underlying inflation is more stubborn than we expected. And we know historically that once it comes to wages and prices of services, they become very permanent components of price dynamics. Hard to put the genie back in the bottle. I think once we hit peak rates, we should be there for quite a long time.”

Germany has entered a recession. Will it become a problem in Europe?
“I wouldn’t say. The economic structures of the euro area countries are different and there will always be specific shocks for each of them. Germany has some specific problems: the dependence on the car sector, which is partly heavily dependent on exports to China. The automotive industry is facing an important transition, including the phasing out of internal combustion engines. And relations with China are more tense than before, with negative consequences for export opportunities. But I trust the ability of political decision-makers to facing challenges”.

Are rate hikes likely to have destabilizing effects in Europe, not so much on banks as on insurance companies, private markets or pension funds?
“Life insurance and pension funds are protected by nature because they also have long-term liabilities (not just long-term assets, ed). On the other hand, from a liquidity standpoint, I’m a little more concerned about mutual funds, money market funds, and the like. Some of these funds still offer the illusion of daily payouts while locked into long-term investments: not just bonds, even commercial real estate. This definitely requires vigilance. It requires strengthening of liquidity management tools within these financial institutions. It is precisely the work program of the Financial Stability Board. It is one of our cornerstones and must be put into practice in the euro area as well».

How concerned are you about the debt evolution in Italy and Spain?
“Government debt has generally increased in euro area countries. The phenomenon is more pronounced in some countries of the South, but there is also an intermediate group of countries, such as Belgium and France, where public debt has risen quite dramatically. Understandable, given the shocks we have had to endure in which fiscal policy has had to partially pay for itself. But now is the time to withdraw fiscal support and reduce the debt ratio. It is of the utmost importance. Governments face higher borrowing costs as we have to fight inflation. They will need to have higher primary balances to offset higher borrowing costs. This adjustment will have to happen and there is not an infinite amount of time available to do it. It will have to happen this year and next year.’

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