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Wednesday, October 5, 2022

ECB poised for big rate hike

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After raising interest rates for the first time in over a decade at their last meeting, European Central Bank policymakers are poised to deliver another bumper hike on Thursday in a show of determination to tame soaring inflation.

Steep increases in the price of energy in the wake of the Russian invasion of Ukraine have heaped pressure on households and sent the pace of consumer price rises to new highs.

The ECB was unlikely to raise its rates “with the explicit goal of strengthening the currency”, said Frederik Ducrozet, head of macroeconomic research at Pictet, but the euro’s struggles against the greenback could “have some bearing on its decision-making”.

The Frankfurt-based institution is playing catch-up with other central banks in the United States and Britain that started raising rates harder and faster in response to inflation.

The “only question” for the ECB’s meeting this week was “whether it will be a 50 or 75 basis point hike,” said Carsten Brzeski, head of macro at the ING bank.

Speaking at the annual Jackson Hole central banking symposium at the end of August, ECB board member Isabel Schnabel said the central bank needed to show “determination” to tame price rises.

Under this approach, the central bank would respond “more forcefully to the current bout of inflation, even at the risk of lower growth and higher unemployment”, she said.

In her speech in the US, Schnabel stressed the need for the people to “trust” that the ECB will restore their purchasing power.

The ECB’s 25-member governing council surprised with a 50-basis-point hike at its last meeting in July, bringing an end to eight years of negative interest rates in one fell swoop.

So-called forward guidance issued by the ECB, which limited its scope for action, has been ditched. Policymakers would now take their decisions “meeting-by-meeting”, the ECB President Christine Lagarde announced in July.

With that, the door has been opened for the ECB to follow in the footsteps of the US Federal Reserve and raise rates by a 75 basis points.

Following August’s red-hot inflation numbers, the influential head of the German central bank, Joachim Nagel, said the ECB needed a “strong rise in interest rates in September”.

“Further interest rate steps are to be expected in the following months,” the Bundesbank president predicted.

But the ECB’s chief economist, Philip Lane, has counselled colleagues to follow a “steady pace” of interest rate rises.

Hiking at a rate that was “neither too slow nor too fast” was important due to the “high uncertainty” around the economy and the future path of inflation.

Alongside its policy decisions, the ECB will also share an updated set of economic forecasts for the eurozone.

In its last estimates, published in June, the ECB said it expected inflation to sit at 6.8 per cent in 2022 before falling to 3.5 per cent next year, while growth would slow from 2.8 per cent this year to 2.1 in 2023.

But a more severe energy shock as Russia reduces gas deliveries to Europe could push the eurozone into a “deeper winter recession” and hold growth to zero per cent in 2023, said Ducrozet.

At the same time, the soaring cost of energy would drive inflation close to double digits by the end of the year, he predicted.

The ECB had “no choice but to commit to faster monetary tightening as long as inflation keeps rising” even as a recession loomed, said Ducrozet.

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