Klaas Knot, President of the Bank of Holland and Financial Stability Board, spoke to Corriere della Sera, El Mundo (Spain), Handelsblatt (Germany) and Les Echos (France) this week. (Here the English version of the interview: English version)

Mr Governor, industrial production in the euro area is declining and raw material costs are below the level of a year ago. Do you think inflation can stay high?
“Uncertainty about this is high, but energy prices have impacted other parts of the consumer goods basket as well. Inflation has increased. Underlying inflation is our main concern today and it still shows no sign of abating, particularly in the services sector. In fact, manufacturing activity appears to be declining. For now, however, we are not seeing any slowdown in services. Most services are labor intensive and wage developments are one of the main upside risks to the inflation outlook. Headline inflation has clearly peaked, but for core inflation we’re not sure we’ve reached it yet. As policymakers, we need to be confident that there will be a significant fall in underlying inflation.”

According to ECB Vice President De Guindos, monetary tightening is in the final phase. For Bundesbank President Joachim Nagel, the increases are likely to continue after the summer. Where do you see the peak in tariffs?
“I don’t know yet, we have to rely on the data. I think we will need more rate hikes in June and July; the new data is unlikely to change dramatically in the meantime. I am confident that our analysis will show the need for at least two more 25 basis point rate hikes. But I’m completely open to what happens after the summer. It’s too early to tell.

Are you confident that the euro area avoided a recession?
“The full impact of monetary tightening is not yet felt, leading to uncertainty about growth prospects.” In any case, growth in the euro area will not be very lush. We are facing a period of low to moderate growth. Then, of course, there is always the danger that we could very quickly slide into a recession in the event of another shock. But that’s not my base case. I think we will have low growth in 2023 and maybe even 2024.”

Do you expect high interest rates in two, three or four years?
“I would describe what we are doing now as a slower and more lengthy action. We went from 50 basis point rate hikes to 25 basis points in May. There is general agreement in the Governing Council that even if we do reach peak interest rates at some point in the not too distant future, we will likely have to stay at those levels for an extended period of time. Market expectations of rate cuts are overly optimistic. Underlying inflation is more persistent than we expected. And we know from the past that wages and prices for services are becoming very permanent components of price dynamics. It’s difficult to get the genie back in the bottle. I think once we hit peak rates, we’re going to have to stay there for quite a long time.”

Germany has entered a recession. Will it become a problem in Europe?
“I wouldn’t say. The economic structures of the countries in the euro area are different and there will always be special shocks for each country. Germany has a few specific problems: its dependence on the automotive sector, which in part depends heavily on exports to China. Among other things, “The automotive industry is facing a major transition as it moves away from the internal combustion engine. And relations with China are more strained than before, negatively impacting export opportunities. But I have faith in the ability of policymakers to meet these challenges.”

Can interest rate hikes in Europe have a destabilizing effect, not so much on banks but on insurance companies, private markets or pension funds?
“Life insurance and pension funds are naturally protected because they also have long-term liabilities (not just long-term assets, ed). On the other hand, I’m a little more worried about mutual funds, money market funds and the like from a liquidity perspective. Some of these funds still offer the illusion of daily payouts, but are tied to long-term investments: not just bonds, but also commercial real estate. This absolutely requires vigilance. It requires a strengthening of liquidity management tools within these financial institutions. That is precisely the work program of the Financial Stability Board. It is one of our cornerstones and should also be put into practice in the euro area.”

How concerned are you about the development of debt in Italy and Spain?
“Government debt has generally increased in euro area countries. The phenomenon can be observed more clearly in some southern countries. But there is also a middle group of countries, such as Belgium and France, where government debt has increased quite dramatically. This is understandable given the shocks we have suffered, which have seen part of the budgetary policy pay off. But now is the time to withdraw fiscal support and lower the debt ratio. It is of the utmost importance. Governments face higher financing costs because we have to fight inflation. You must have higher primary balances to offset higher borrowing costs. This adaptation must take place and there is not an infinite amount of time available for this. “It has to happen this year and next.”