A preview of the illumination at the ECB headquarters for the 20th anniversary of the Euro in Frankfurt.
WASHINGTON Reuters -- The European Central Bank must move ahead with interest rate hikes to tame inflation and should even push borrowing costs to levels that restrict economic activity despite rising recession risks, policymakers said on Friday.
The ECB has lifted rates by 125 basis points at its past two meetings, the fastest pace of policy tightening in record, starting slowly and picking up pace in recent months.
For months it said the goal was to lift rates to a neutral setting, where it was neither stimulating nor slowing growth. Some policymakers are arguing that the neutral rate, seen somewhere between 1.5% and 2%, is not enough.
Peter Kazimir, Slovakia's central bank chief, told Reuters that "we won't stop at the neutral rate. We need to keep powering through."
Bostjan Vasle, Slovenia's central bank governor, said he was among a small but increasing chorus of policymakers making the case for a foray into restrictive territory, a policy path now embraced by other central banks, including the U.S Federal Reserve.
Vasle said that we will have to go above the neutral level in order to calm inflation pressures, which are currently in the pipeline.
In Washington for an annual meeting of the International Monetary Fund and World Bank, both Kazimir and Vasle made the case for a 75 basis point increase in the ECB's deposit rate on October 27. Vasle said a similar move could come in December.
The rapid rate hikes come against a deteriorating economic outlook and the ECB Vice President Luis de Guindos warned on Friday that the negative scenario in the bank's most recent growth projection may be materializing.
In September, what we considered as a downside scenario is closer to the baseline scenario, de Guindos told Lithuanian weekly Verslo inios.
He said that we are going to have a very difficult combination of low economic growth, including the possibility of a technical recession and high inflation.
Financial markets may be too optimistic about the economic outlook, raising the risk of an abrupt market correction and financial instability, ECB chief Christine Lagarde warned on Friday.
Lagarde said that the valuations are vulnerable to a wide variety of negative surprises, whether it's growth, inflation, monetary policy or corporate profitability.
The ECB could begin a quantitative tightening or a reduction of its 9 trillion euro balance sheet if interest rates hit the neutral territory.
This would be done by not investing all the cash maturing in the ECB's 3.3 trillion euro Asset Purchase Programme, but both Kasimir and Vasle said it could be done until next year.
Sources told Reuters earlier this month that policymakers had discussed a timeline for quantitative tightening, which was to start sometime in the second quarter.
Sources told Reuters that the European Central Bank could make changes to its language on reinvestments at its October meeting and could possibly provide a detailed plan in December or February.