Markets are “getting ahead of themselves” with expectations of interest rate cuts, Dutch Central Bank President Klaas Knott told CNBC on Wednesday.
“The problem for us is that this could ultimately be self-defeating. We are optimistic that we have a reasonable prospect of inflation returning to 2% in 2025. But there is still a lot that has to go wrong for that to happen,” said Knott, a member of the bank. European Central Bank speaking at the World Economic Forum in Davos.
“Underlying this expectation is an interest rate path, the assumed interest rate path, which contains much less easing than is currently implicit in market pricing. This runs the risk of becoming self-defeating.”
Knott said the eurozone central bank was looking at overall financial conditions, and that “the more easing the market has already given us, the less likely we are to cut interest rates.”
“I think there are expectations about interest rate movements in current markets that we will not be able to defend. Once it becomes clear to the markets that we will not defend that, I would expect some correction back to the interest rate path that was the reason we were so optimistic about a deal.” “. He added: “A gradual return to the 2% inflation rate in 2025.”
European Central Bank officials in Davos this year largely pushed back against market expectations of interest rate cuts starting in the spring.
Austrian Central Bank President Robert Holzmann, a key ECB hawk, told CNBC on Monday that there are threats to the inflationary picture that could mean interest rates won’t fall at all this year.
But his more pessimistic colleague, Portuguese Central Bank Governor Mario Centeno, painted an optimistic picture of the inflation path.
Knott said on Wednesday that the European Central Bank would stick to its plan to lower inflation, while battling risks from a tight labor market and geopolitical uncertainty in the Red Sea.
“If we were to remove some of the restrictions we currently have in place, it would be a very gradual withdrawal, but not a sudden withdrawal,” he added, adding that more data on wages was needed.
Knott said he agrees with those who say there will be no need to raise interest rates again. The European Central Bank’s key interest rate is currently at a record high of 4%.
He added that the emergence of upside risks to inflation would prolong the time that interest rates remain higher.
He added, “But this may imply that the first cut may come later than currently expected.”