Markets are “overexaggerated” with interest rate cut expectations, Dutch Central Bank President Klaas Knot told CNBC on Wednesday.
“The problem for us is that this could ultimately prove self-defeating. We are optimistic that we have a credible prospect of inflation returning to 2% in 2025. For this to succeed, a lot of things still have to go well,” said Knot, a member of the European Central Bank, in his speech at the World Economic Forum in Davos.
“This forecast is based on an interest rate path, an assumed interest rate path that includes significantly less easing than is currently anchored in market pricing. So that runs the risk of counteracting yourself.”
Knot said the euro zone central bank looked at overall financial conditions and found that “the more easing the market has already done for us, the less likely we are to cut rates.”
“I think there are expectations about the direction of our key interest rates in the current markets that we will not confirm. “Once it becomes clear to markets that we are not going to confirm these, I expect some correction back to the interest rate path that underpinned our optimism, gradually returning to an inflation rate of 2% in 2025,” he added.
At this year's meeting in Davos, ECB representatives largely pushed back market expectations for interest rate cuts in the spring.
Austrian central bank chief Robert Holzmann, an archhawk at the ECB, told CNBC on Monday that there are threats to the inflation situation that could result in interest rates not falling at all this year.
However, his more moderate colleague, Portugal's central bank governor Mario Centeno, painted an optimistic picture of inflation developments.
The ECB will stick to its plan to reduce inflation as it grapples with the risks of a tight labor market and geopolitical uncertainty in the Red Sea, Knot said on Wednesday.
“If we want to lift some of the restrictions we currently have, it will be a very gradual withdrawal, but not a headlong move,” he said, adding that more data on wages was needed.
Knot said he agrees with those who say no further rate hikes are needed. The ECB's key interest rate is currently at a record high of 4%.
He added that the emergence of upside risks to inflation would be more likely to keep interest rates higher.
“But it could mean the first cut could come later than currently expected,” he said.