Bundesbank President Joachim Nagel has come out in favour of further significant interest rate steps. Speaking at a joint press conference with Federal Finance Minister Christian Lindner ahead of the Annual Meeting of the International Monetary Fund (IMF), Dr Nagel said that the latest inflation data argue in favour of the Eurosystem taking a further “robust” interest rate step at its next monetary policy meeting.

However, the Bundesbank President warned that the process of normalising monetary policy would then still not be over. Getting inflation under control is now a top priority. In September, inflation as measured by the Harmonised Index of Consumer Prices (HICP) had stood at 10.9% in Germany and at 10% for the euro area as a whole. The European Central Bank (ECB) aims to achieve a rate of 2% over the medium term.

Tightening of monetary policy necessary

Dr Nagel noted that, after the first two interest rate steps, monetary policy in the euro area was still some distance away from the neutral interest rate, wherever that might be. The President described the ongoing discussions about where the hotly debated neutral interest rate lies as being of little help. Economists refer to the neutral interest rate as the interest rate at which the economy neither speeds up nor slows down. Since July, the ECB has raised key interest rates by 125 basis points over two steps, bringing them back into positive territory.

Dr Nagel stressed that, generally speaking, tightening monetary policy was necessary to prevent inflation expectations from becoming unanchored. The President said he believed that persistently high inflation would ultimately be the biggest drag on growth and the greatest destroyer of wealth for the economy. Dr Nagel also pointed out that the Eurosystem would have to reduce its large holdings of bonds purchased under various programmes as a further necessary monetary policy measure, saying that he was lobbying on the Governing Council for this reduction to be tackled in a timely manner. He believes this reduction can begin next year, stressing that the large balance sheet is not compatible with the process of raising interest rates.

Inflationary pressures remain high

In light of his monetary policy assessment, President Nagel cautioned that inflation in Germany and the euro area as a whole would be high not only this year, but that it would remain high next year as well. In this respect, he also considers it more likely that, on an annual average for 2023, there will be a seven before the decimal point rather than a six in the wake of 8% inflation this year. And given the tensions in the energy markets, he believes that there continues to be significant upside risks to the inflation rate, warning that Inflation could remain elevated for even longer.

Looking at real economic developments in Germany, the Bundesbank President spoke of a marked deterioration in the growth outlook, adding that uncertainty surrounding the energy supply and its costs has been increasingly weighing on investment and consumption. All in all, he believes a “mild recession” is to be expected for Germany against such a backdrop. In this connection, President Nagel also referred to the IMF’s latest forecasts, which expect German economic output to decline by 0.3% next year. He explained that this development would help to bring inflation down in Germany.