Daily Management Review

A Large Rate Hike Could Be Implemented By European Central Bank With The Slowing Of The Economy Toward A Recession


A Large Rate Hike Could Be Implemented By European Central Bank With The Slowing Of The Economy Toward A Recession
Due to the rising cost of living, which is on the verge of increasing even further, the European Central Bank is anticipated to frontload a number of rate increases and sacrifice regional growth.
Isabel Schnabel, a member of the ECB Executive Board, set the tone for this week's policy meeting with her speech in Jackson Hole. A "jumbo" rate hike of 75 basis points on Thursday is undoubtedly possible given the euro zone's predicted rise in inflation to at least 10 per cent and the risk of skyrocketing consumer prices.
“As frontloaded hikes can have a bigger impact on inflation expectations than a more gradual approach, a 75bp move could make sense,” said ECB watcher and Berenberg’s Chief Economist Holger Schmieding in a research note.
“Although it is largely priced in, it could still exacerbate strains in the bond markets.”
Italian government 10-year yields have risen to 4 per cent, the highest level since mid-June even before ECB declared the formation of an anti-fragmentation tool, as a result of the recent suspension of gas deliveries to Europe via the Nord Stream 1 pipeline. This has not only caused stocks to decline and raised the risk of a European recession. The government in Rome must pay more to borrow money because of Italy's high yields, which are significantly higher than those in Germany, raising concerns about the country's significant debt load.
With the continued pressure on energy prices, inflation in the euro zone reached 9.7% in August, and it is anticipated to reach double-digit levels in the coming months.
Simultaneously, as consumers cut back on their spending and businesses struggle with high energy prices, there is a significant risk of a recession for the regional economy.
“While governments will partially ‘foot the bill’, there are limits to what extent the private sector can be shielded from this income shock,” said Dirk Schumacher with Natixis in a research note to clients.
“The drop in consumer confidence to a record low over the last months, indicates that households are aware of these limits with respect to government support. There is also increasing evidence that companies in energy intensive sectors are reducing production.”
The ECB is anticipated to sacrifice growth in order to maintain anchored inflation expectations due to the inflation outlook, as this is the bank's primary mandate.
“A key take away from recent comments by ECB officials is that the hiking cycle will be less sensitive to recession than we thought,” said Deutsche Bank’s Chief Economist Mark Wall in a research note.
“We raised our terminal rate forecast by 50bp to 2.5%,” he added. The ECB’s benchmark rate is currently at zero.
A steady economy's "neutral" rate, according to the Frankfurt institution, should be between 1% and 2%. However, as inflation risk increases, the ECB's Governing Council may need to consider raising rates above that range into tightening territory.
That also raises the pertinent question of about the future of quantitative tightening - a technical term that is used to describe shrinking the balance sheet of the central bank. The ECB has not yet discussed the issue of selling assets.
“Given the threat to the ECB’s credibility, we also wonder why quantitative tightening is not discussed,” Anatoli Annenkov of Societe Generale, said in a research note. “Not using QT should imply higher rates.”