ECB must prepare for higher inflation – Knot

FRANKFURT (Reuters) – Euro zone inflation is likely to fall back below 2% late next year but the European Central Bank should prepare for a less benign scenario, avoiding long policy commitments as upside risks dominate, Dutch policymaker Klaas Knot said on Tuesday.

Inflation rose above 4% last month, more than twice the ECB’s 2% target. But the bank has pushed back on calls for tighter policy, arguing transitory forces are behind the rise and inflation will fall below its target in the years to come.

Knot, a conservative member of the rate-setting Governing Council, also made the case for “largely transitory” price pressures, but warned that some of the temporary factors at play may be more durable than once thought.

“Upside risks to this baseline dominate,” Knot said in a panel discussion hosted by UBS. “And we need to prepare for upside scenarios as well.”

Knot’s comments come just weeks before the ECB is due to decide on winding down a 1.85 trillion euro ($2.14 trillion)stimulus scheme – the Pandemic Emergency Purchase Programme – and will likely consider scaling up other tools to pick up the slack.

In this crucial decision, the ECB should not bind itself for too long because more durable inflation could require policy action sooner than some now think.

“We cannot make long-lasting unconditional commitments that might end up being incompatible with how the inflation outlook develops,” Knot said.

Once the emergency purchases end next March, a less flexible Asset Purchase Programme should be the bank’s main tool and the ECB should keep the door open to both increasing and decreasing bond buying volumes under this scheme, Knot argued.

The effects of tax hikes and past oil price rises will indeed fade, Knot said, but supply chain bottlenecks and future energy price rises may keep up the inflationary pressure.

“These transitory pressures are not necessarily short-lived,” Knot said. “In fact, we have come to realize that the inflationary pressures from these sources last longer than initially thought.”

Wages could also rise faster than now thought, especially if the current bout of inflation is longer lasting and firms start to adjust their wage policy.

Still, conditions for an interest rate hike are “very unlikely” to be met next year, Knot said, echoing the most recent guidance repeated by a host of ECB policymakers in the past week

($1 = 0.8655 euros)

(Reporting by Balazs Koranyi; Editing by Mark Potter)

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