The European Central Bank is nearing the peak of its interest-rate hiking cycle, Governing Council member Mário Centeno said in an interview, adding that policymakers must avoid unnecessary damage to the economy in their battle against inflation.

Speaking to POLITICO after two weeks of financial market turmoil, he called on fiscal authorities to reinvigorate a broader push for a banking union and joint debt instruments.

“We are really approaching the top of this curve,” Centeno said about the policy path ahead, after the central bank raised interest rates by a half percentage point last week even as fears about the health of the global financial system stalked the financial markets.

The remarks by the Bank of Portugal governor and the country’s former finance minister underlined the diverging views among policymakers on the ECB’s Governing Council. While fellow dove Greek central bank governor Yannis Stournaras has also suggested the ECB might be just about done in the current rate-increasing cycle, the Council’s super-hawk, Austrian Robert Holzmann, reckons rates may still have some way to go.

Battling record inflation, the ECB has raised interest rates from -0.5 percent last summer to 3 percent in March, in its fastest-ever tightening cycle. While inflation has come off its peak, it continues to run at close to three times the central bank’s 2 percent target.

“We need to send a clear message that we’re going to fight inflation and that the domestic sources of inflation cannot become entrenched. In that case, we need to use interest rates, make no mistake,” said Centeno. “But we cannot use them in a way that will have a ratchet effect on inflation, the economy and financial stability, we cannot go above what is necessary.”

Centeno stressed that the ECB’s previous tightening efforts must be given time to unfold. “It’s not so much the level of the rate, but the speed of adjustment that concerns me,” he said.

The Portuguese, who previously chaired meetings of eurozone finance ministers, would not be drawn into making a call for the ECB’s May decision given the current uncertainty and the central bank’s dependency on fresh economic data. But he pointed to latest forecasts by the European Commission and the ECB which now see inflation dropping back toward the bank’s 2 percent target faster than previously thought.

“We need to reflect this in our decisions,” he said. “My takeaway from these forecasts is that we really are making progress towards reaching our objective. We need to be patient.”

Easy on QT

Centeno also said ECB policymakers must be mindful of financial stability concerns when deciding on how fast to unwind its government bond portfolio built up during previous crises. 

The ECB has previously announced that it will reduce its holdings by about €15 billion per month from the beginning of March until the end of June, before reassessing the speed of reduction. Some policymakers have called for a more aggressive approach to shrinking the central bank’s bond portfolio.

“This process is a must, but it cannot jeopardize our main goal,” Centeno said. “Our history tells us that we had to backtrack a couple of times already during processes of tightening given threats to financial stability. We cannot risk that this time.” He added: “This is not financial dominance, it is feasibility.”

The ECB was forced to abort tightening cycles in 2008 and 2011 as the financial and sovereign debt crisis hit. Widely accepted as policy errors in hindsight, the moves were particularly painful for countries facing bailouts at the time, including Portugal. “We cannot risk that this time.”

Back to the table

Centeno was pleased the eurozone had weathered the recent storm on financial markets without emerging doubts over the integrity of the currency union. He ascribed this to the ECB’s expanded toolbox and Europe’s decision to issue joint debt in response to the global pandemic.

Still, he stressed that, irrespective of significant progress made, “the lesson from the recent market turmoil is that in Europe, we need to complete the banking union,” and that more broadly the integration process in Europe must continue, adding in particular that Europe should return “very quickly” to a joint fiscal capacity.

“I think the sentiment, both politically and financially, in Europe towards the integration debate is good. We should go back to the table and make progress in these areas,” Centeno said.