FRANKFURT (Reuters) – 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 percent deposit rate.
The latter would be the biggest ever hike 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 already expected to usher in a winter recession consistently exceed even the most pessimistic forecasts.
Buoyed by hawkish comments from conservative policymakers, markets have now nearly priced in a 75 basis point hike. A slim majority of economists polled by Reuters are also predicting the larger increase.
“We think it is a very close call, with good arguments on each side, but ultimately think those advocating for a larger hike will prevail as September offers the best opportunity to send a clear signal of determination,” Morgan Stanley (NYSE:MS) economist Jens Eisenschmidt said.
“Be it 50 or 75 basis points, … we see the ECB hiking cycle ending at 2% in March.”
The decision also encapsulates a policy dilemma.
Updates to ECB forecasts are certain to show sharply higher inflation and 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% while its underlying rate is 4.3%, 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 U.S. Federal Reserve is clearly raising rates faster, which would in turn further fuel inflation as energy is denominated in dollars.
That is why nearly a half dozen policymakers have publicly backed putting a 75 basis point option on the table, giving the debate a hawkish momentum.
The coming recession also makes the case for frontloading 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 is increasingly tight, could provide relief to firms now struggling to find workers.
“We expect rate hikes of 75, 50 and 25 basis points in the forthcoming meetings this year, taking the deposit rate into neutral territory as the economy slows, and another three 25 basis point hikes next year,” Societe Generale (OTC:SCGLY) economist Anatoli Annenkov said.
On top of the rate announcement, the ECB will likely debate changing how it pays interest on excess reserves parked by commercial banks, which are now set to 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.
Source: Economy - investing.com
