Eurozone inflation is likely to fall back below 2% late next year, but the European Central Bank should prepare for a more bleak scenario, avoiding long policy commitments as upside risks dominate, according to Dutch policymaker Klaas Knot on Tuesday.
Inflation surpassed 4% last month, more than doubling the ECB's target of 2%. However, the bank has resisted calls for tighter policy, arguing that the rise is due to transitory forces and that inflation will fall below its target in the coming years.
Knot, a conservative member of the Governing Council, agreed that price pressures are "largely transitory," but warned that some of the temporary factors at work may be more durable than previously 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 remarks come just weeks before the ECB is expected to decide whether to wind down a 1.85 trillion euro ($2.14 trillion) stimulus scheme known as the Pandemic Emergency Purchase Programme, and whether to scale up other tools to make up the difference.
The ECB should not bind itself for too long in this critical decision because more durable inflation may necessitate policy action sooner than some currently believe.
“We cannot make long-lasting unconditional commitments that might end up being incompatible with how the inflation outlook develops,” Knot said.
When the emergency purchases expire in 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, according to Knot.
The effects of tax increases and past oil price increases will fade, according to Knot, but supply chain bottlenecks and future energy price increases may keep inflationary pressures high.
Nonetheless, conditions for an interest rate hike are "very unlikely" to be met next year, according to Knot, echoing recent guidance repeated by a number of ECB policymakers in the past week.