ECB determined to hit hard against inflation

Posted 06 September, 2022

After a first rate hike larger than expected in July, the European Central Bank (ECB) is once again caught up in inflation records and could accelerate the tightening of its monetary policy on Thursday.

“The only question is whether an increase of 50 or 75 basis points” in reference rates will be decided after the Board of Governors, judge Carsten Brzeski, an economist at ING.

The second option is the hypothesis favored by observers as prices rose by 9.1% over one year in the euro zone in August, a record since the creation of the single currency and a score very well above the rate of 2% targeted by the ECB in the long term.

The ECB had a firm hand in July by raising its three rates by half a point, the first increase in more than ten years after an era of generous monetary policy which had helped to stimulate the economy.

The only path now possible for the guardians of the euro is that of “determination” against inflation, and this “even at the risk of weaker growth and higher unemployment”, argued at the end of August Isabel Schnabel, member of the Executive Board of the ECB.


Underestimated inflation


The dilemma between rising prices and fears of recession has slowed the action of the ECB for the past year, while other major central banks have launched a cycle of rate hikes.

"If a central bank underestimates the persistence of inflation - as most of us have over the past year and a half - and is slow to adjust its policies accordingly, the costs can be considerable”, admitted Ms. Schnabel, acknowledging that the ECB had believed for too long that the inflationary shock would be short-lived.

Consumers in the euro zone are now doubtful that the monetary institute will be able to bring inflation back within its mandate, according to a recent ECB study that they see inflation still at 3.0 % in three years.

It is essential that the public maintain "confidence in (...) our ability to preserve purchasing power", insisted Ms. Schnabel.


Preserve purchasing power 


In the United States, which is more advanced in terms of monetary tightening, the key rates of the Federal Reserve (Fed) are already between 2.25 and 2.50%.

The ECB raised its rates at the end of July between 0% and 0.75%.

At the same time, faced with economic uncertainties, it has decided to navigate on sight and suspend the use of “forward guidance”, which in recent years consisted of warning economic agents of its intentions.

Enough to find some leeway to follow in the footsteps of the Fed, which recently raised its key rates by 75 basis points.

The President of the German Central Bank, Joachim Nagel, “hawk” of monetary policy, has already called for “a sharp rise in interest rates” in September and the months to follow. Other euro zone governors have come out in favor of raising rates by 75 basis points.

Only chief economist Philip Lane qualified the statement, advising to follow a "regular rhythm" of rising interest rates that is "neither too slow nor too fast".


Winter recession


The monetary institute will have new economic forecasts on Thursday which will take into account the effect of the reductions in the delivery of Russian gas to Europe on the industrial sector.

The latest projections from the ECB were still counting on a GDP growing by 2.1% next year, but most institutes now see the euro zone entering recession this winter.

In this context, further rate hikes in October and December could "exacerbate tensions in the bond market" and make borrowing conditions more expensive for countries in the euro zone deemed to be more vulnerable, such as Italy, warns Holger Schmieding, economist at Berenberg.

The ECB could then inaugurate its new tool, presented this summer, intended to enable it to intervene in the markets in order to counter speculative attacks on debt.

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