ECB may start cutting the balance sheet when the rate becomes neutral

The president of the central bank of the Netherlands, Klaas Knot, said that once the interest rate increases to a level that will neither push the economy to grow nor slow it down, the ECB should consider cutting its own assets, which, according to Knot, are too large. 

Over the past few months the interest rate has been rising quite rapidly, for this reason many analysts believe that by the end of the year the rate will become neutral, that is, it will grow to 1.5-2%. Knot didn’t give more precise numbers, but said that it should be plausible. 

In Washington, Knot also said that asset reduction will be possible once the neutral level is reached. The plan is to cut assets by reducing the level of reinvestment. He also noted that it’s necessary to move gradually. 

Initially, it was planned that the balance sheet cutting would mainly concern the Asset Purchase Program and the debt (3.3 trillion euros) within it. This policy is called quantitative tightening. 

However, Knot doesn’t believe the ECB will stop by raising rates to a neutral level, it will probably need to rise to a level that will be able to restrain growth. Moreover, he believes more efforts must be made to stabilize prices. Generally, Knot doesn't expect the increases to stop abruptly. He hopes that the necessary, not so high, inflation rate will return with the increases. Only in this case growth is expected to slow down. 

On October 27 Knot spoke in support of a significant interest rate increase, the significant increase was 75 bps. But then the president of the central bank of the Netherlands was confident that the pace of interest rate hikes would slow down and the ECB would move gradually.