Cyprus Mail
Banking and FinanceBusinessEuropeInternational

ECB poised for another big rate hike as inflation soars

ecb euro

The European Central Bank will raise interest rates again on Thursday to fight runaway inflation and, with a big move and a record one under consideration, the only question is by how much.

Concerned that sky-high inflation is getting increasingly entrenched, policymakers are scrambling to keep a lid on the bloc’s most damaging bout of price growth in nearly half a century as it eats up household savings and weighs on business output.

Ultimately, the choice will be between a 50 and a 75 basis point increase in the zero per cent deposit rate, with expectations now leaning towards a bigger increase but not with full conviction.

The larger move would be the biggest ever increase of the ECB’s benchmark rate, but regardless of the outcome, the bank’s direction of travel will be clear.

More hikes are factored in for coming months as price pressures are consistently exceeding even the most pessimistic forecasts.

Buoyed by hawkish comments from conservative policymakers, markets now see a more than 80 per cent chance of a 75 basis point hike. A slim majority of economists polled by Reuters are also predicting a larger increase.

“With the hawks continuing to hold the upper hand, we think the ECB will deliver a 75 basis point increase,” BNP Paribas economist Paul Hollingsworth said. “We now expect a more front-loaded tightening cycle that takes the deposit rate up to a terminal rate of 2 per cent by the end of the first quarter.”

The decision also encapsulates a policy dilemma.

Updates to ECB forecasts are certain to show sharply higher inflation but significantly weaker economic growth.

Sky-high energy prices will sap purchasing power and almost certainly plunge the bloc into a recession that could be exacerbated by an aggressive ECB, especially with borrowing costs rising for governments as they try to help those most affected.

A big hike after a decade of ultra-low rates also goes against the ECB’s guidance for gradualism and several policymakers, including board member Fabio Panetta and Greek central bank chief Yannis Stournaras, have made the case for a smaller move.

Central banks are also powerless against inflation driven by supply-side disruptions, and rate hikes now will affect the economy years down the road, when inflation is abating on its own.

CREDIBILITY

However, timid action now could push up long-term inflation expectations from already high levels, weakening the ECB’s inflation-fighting credibility and challenging the very framework of its mandate.

Headline euro zone inflation is over 9 per cent while its underlying rate is 4.3 per cent, more than twice the ECB’s target, indicating that more and more of the energy-driven price pressures are seeping into the broader economy.

A smaller move would also weaken the euro as the US Federal Reserve is clearly raising rates faster, which would in turn further fuel inflation making energy denominated in dollars even more expensive.

Trading at parity against the dollar, the euro is not far above a two-decade low it hit this month.

That is why nearly a half dozen policymakers have publicly backed putting a 75 basis point option on the table.

The coming recession also makes the case for front-loading rate hikes as moving aggressively once the downturn takes hold will be difficult to communicate.

Some policymakers may even welcome a shallow recession that, with the bloc’s labour market increasingly tight, could provide relief to firms now struggling to find workers.

“If the ECB decides on 50bp, it may come with a reference to a ‘steady pace’ of rate hikes, pointing to further 50bp moves in October and December and/or other elements indicating a significant further tightening of monetary policy in the coming months,” Berenberg economist Holger Schmieding said.

Along the rate announcement, the ECB will likely debate changing how it pays interest on excess reserves parked by commercial banks, which now enjoy a risk-free windfall on trillions of euros worth of cash circulating in the financial system.

The ECB may also discuss whether to start reducing its balance sheet as part of its policy normalisation process.

However, no decision is expected in either of these areas.

The ECB announces its policy decision and presents the new economic projections at 1215 GMT, followed by President Christine Lagarde’s news conference at 1245 GMT.

Follow the Cyprus Mail on Google News

Related Posts

Cyprus Business Now

Kyriacos Nicolaou

Cyprus petroleum sales rise by 7.1 per cent in February

Kyriacos Nicolaou

Britain’s financial watchdog warns social media influencers

Reuters News Service

Renault to sell Nissan stake of about 2.5 per cent

Reuters News Service

Japan makes strongest intervention warning as yen hits 34-year low

Reuters News Service

CySEC toughens oversight on cross-border activities

Andria Kades