European Central Bank could unleash jumbo rate hike as economy slides into recession

FRANKFURT, Germany — The European Central Bank is expected to bring forward a series of rate hikes and sacrifice growth in the region as the cost of living threatens to rise even higher.

The speech by ECB executive Isabel Schnabel in Jackson Hole set the tone for the upcoming policy meeting this week. With inflation in the euro-zone expected to rise to at least 10% in the coming months and the risk of consumer prices skyrocketing, a “jumbo” rate hike of 75 basis points on Thursday is certainly a possibility.

“Since rapid increases can have a greater impact on inflation expectations than a more gradual approach, a 75 basis point move could make sense,” said Holger Schmieding, chief economist at the ECB and Berenberg’s chief economist.

“While it’s largely priced in, it could exacerbate bond market tensions.”

The recent cessation of gas supplies to Europe via the Nord Stream 1 pipeline has not only pushed stocks down and increased the risk of a recession in Europe, it has also pushed the Italian government’s 10-year yield to 4% – the highest level since mid-June before the ECB announced the creation of an anti-fragmentation tool. High yields for Italy – much higher than those in Germany – mean that the government in Rome has to pay more to borrow, raising concerns about the heavy mountain of debt.

Eurozone inflation reached 9.7% in August and with continued pressure on energy prices, it is expected to reach double digits in the coming months. At the same time, the risk of a recession looms large for the region’s economy as consumers feel the pain and cut back on consumption, and businesses struggle with high energy prices.

“While governments will partially foot the bill, there are limits to the extent to which the private sector can be protected from this income shock,” Dirk Schumacher told Natixis in a research note to clients.

“The drop in consumer confidence to an all-time low in recent months indicates that households are aware of these limits on government support. There is also mounting evidence that companies in energy-intensive sectors are cutting production.”

Given the inflation outlook, the ECB is expected to sacrifice growth to keep inflation expectations anchored, as this is the bank’s core mandate.

“An important conclusion from recent comments from ECB officials is that the walking cycle will be less prone to recession than we thought,” Deutsche Bank chief economist Mark Wall said in a research note.

“We have raised our final rate forecast by 50bp to 2.5%,” he added. The benchmark interest rate of the ECB is currently at zero.

The Frankfurt institution believes that its “neutral” interest rate – an optimal level for a stable economy – is between 1% and 2% and with inflation risk rising, the Governing Council of the ECB should consider raising interest rates above that level. increase to get tighter.

Of course, that also raises the question of quantitative tightening – the technical description for shrinking the central bank’s balance sheet. The sale of assets has not yet been discussed by the ECB.

“Given the threat to the ECB’s credibility, we also wonder why quantitative tightening is not being discussed,” Societe Generale’s Anatoli Annenkov said in a research note. “Not using QT should imply higher rates.”