The European Central Bank will join the US Federal Reserve in outsize rate hikes


FRANKFURT, Germany (AP) – The European Central Bank will join the US Federal Reserve to launch a jumbo rate hike on Thursday to stamp out record inflation – despite the risk of a deepening recession economists say weighs on Europe.

The meeting of the bank’s board of directors will not be about whether interest rates for the 19 countries that use the euro currency will be raised, but by how much: between half a percentage point and three-quarters of a point, analysts say. The bank made its first raise in 11 years at its last meeting in July, it raised interest rates by half a point when they normally change by only a quarter point.

The ECB, which once forecast no rate hikes at all this year, has scrambled its roadmap in the face of record inflation at 9.1%. last month, fueled by skyrocketing natural gas prices and lasted much longer than expected. Inflation is well above the bank’s 2% target, which is considered the healthiest for the economy.

The central bank’s justification for a three-quarter point hike would be that “doing nothing today would lead to larger moves and higher costs going forward,” said Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management.

The price of natural gas — used to generate electricity, heat homes and run factories — has increased more than tenfold as Russia has cut supplies while tensions mount over the war in Ukraine. European politicians call it blackmail for their support for Kyiv.

The resulting inflation makes everything from groceries to utility bills more expensive, creating a cost-of-living crisis this will only get worse as many economists predict the euro zone will slide into recession End of this year and until 2023.

At her last press conference in July, ECB President Christine Lagarde said that according to the bank’s baseline economic forecast, “there is no recession, either this year or next. Is the horizon clouded? Of course it is.”

Rate hikes are the typical central bank antidote to higher inflation. Higher interest rates affect the cost of borrowing throughout the economy, making credit, consumption and investment more expensive and thus dampening demand for goods. The problem is that inflation stems not so much from demand as from the supply side of the economy – oil and natural gas costs – which the ECB can do little to address directly.

The ECB has lagged other central banks on rate hikes and analysts say it is now concerned that its credibility as an inflation-fighter is at stake, raising the possibility that rates will rise faster than expected even in a few weeks’ time.

Its benchmark is 0.5% for lending to banks. The Fed’s main benchmark stands at 2.25% to 2.50% after several large rate hikes, including two three-quarter points. The most important benchmark of the Bank of England is 1.75%.

A senior ECB official, Isabel Schnabel, said last month that “determination” is better than “caution” which threatens to burn inflation into people’s price and wage expectations. Then it would be much more difficult to control.

Acting decisively now offers the chance to wipe out excessive inflation “even at the risk of slower growth and higher unemployment,” Schnabel, a member of the six-member board who runs the bank day-to-day, told a Bundesbank reserve on Aug. 27 symposium in Jackson Hole, Wyoming.

Price stability is the Bank’s primary mandate under the Treaty on European Union.

The ECB’s approach is “also at the price of inflicting further pain on households, employees and companies in the short term,” said Holger Schmieding, chief economist at Berenberg Bank. “However, the ECB has good reason to become more aggressive.”

Otherwise, it “could become even more costly in the future” to bring down ingrained inflation, he said.

Higher interest rates would help support the euro’s exchange rate against the dollar by increasing demand for euro-denominated asset holdings. The Euro’s Recent Drop Below $1 – driven by rising energy costs and a dampening economic outlook – increases inflation because it makes imported goods more expensive.

Some think the central bank is overreacting.

“There is a great risk that this decisive approach by the ECB will result not only in less growth and jobs than now, but also less than needed to tame inflation,” wrote Erik F. Nielsen, group chief economics adviser at the UniCredit Bank.

“Increasing concerns about its reputation” could prompt the ECB – and potentially the Fed – to overdo monetary tightening, he added.

“We still find it difficult to see how aggressive rate hikes can lower headline inflation in the eurozone,” said Carsten Brzeski, chief eurozone economist at ING Bank. “The economy is far from overheating and will almost inevitably fall into a winter recession even without further rate hikes.”


Comments are closed.