ECB needs more interest rate rises and smaller balance sheet, says Bundesbank chief

Further increases will be needed to bring inflation back to 2% in medium term, says Joachim Nagel

Bundesbank president Joachim Nagel, centre, at the annual meetings of the International Monetary Fund and the World Bank in Washington. EPA

The European Central Bank (ECB) needs several more rate rises to tame inflation despite what is likely to be a deep recession in Germany, and should also look into scaling down its balance sheet, Bundesbank president Joachim Nagel said on Saturday.

The ECB has raised rates twice already this year, but at 0.75 per cent, its deposit rate is still far below levels most consider to be appropriate when inflation is running at 10 per cent and could hold above the bank's 2 per cent target for years to come.

"Further interest rate hikes will be needed to bring the inflation rate back to 2 per cent in the medium term — not just at the monetary policy meeting at the end of October,” Mr Nagel said in a speech in Washington.

"The ECB Governing Council must not let up too soon.”

Markets currently price in a 75-basis point move on October 27, the same as September's increase, and few if any policymakers have pushed back publicly on these expectations.

"As monetary policy continues to normalise, we will also need to look into scaling back Eurosystem asset holdings, which amount to almost €5 trillion,” Mr Nagel said.

While the ECB has provided no timeline for reducing its balance sheet, a process often called quantitative tightening, policymakers appear to be advocating a start only in 2023, arguing that the bulk of the rate rises should take place before the ECB starts letting some of its debt pile expire.

Monetary policy tightening is needed as inflation is likely to stay high, and Mr Nagel predicted Germany's rate would reach more than 7 per cent next year.

A complication in the process is that the 19-country eurozone faces a recession with Germany, its biggest economy, likely among the biggest losers.

"GDP [in Germany] could decline significantly in the final quarter of 2022 and the first quarter of 2023,” Mr Nagel said.

"This would imply a recession, that is a significant, broad-based and longer-lasting decrease in economic output.”