The European Central Bank may trigger a jumbo interest rate hike

With Eurozone inflation forecast to rise to at least 10% in the coming months, a “jumbo” rate hike of 75 basis points is certainly a possibility.

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FRANKFURT, Germany – The European Central Bank is expected to front-load a series of rate hikes and sacrifice growth in the region due to the rising cost of living that threatens to climb even higher.

ECB Executive Board member Isabel Schnabel̵[ads1]7;s speech in Jackson Hole set the tone for the upcoming policy meeting this week. With eurozone inflation forecast to rise to at least 10% in the coming months and the risk of consumer prices soaring higher, a “jumbo” rate hike of 75 basis points on Thursday is certainly a possibility.

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The European Central Bank may trigger a jumbo interest rate hike

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“As front-loaded hikes may have a greater impact on inflation expectations than a more gradual approach, a 75bp move may make sense,” ECB watchdog and Berenberg chief economist Holger Schmieding said in a research note.

“While largely priced in, it could still exacerbate the strain on bond markets.”

The recent shutdown of gas supplies to Europe via the Nord Stream 1 pipeline has not only depressed stocks and raised the risk of a recession in Europe, it has also pushed Italian government 10-year yields to 4% – the highest level since mid-June before The ECB announced the creation of an anti-fragmentation tool. High interest rates for Italy – much higher than those in Germany – mean the government in Rome has to pay more to borrow, exacerbating concerns over its large debt pile.

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

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“While governments will partially ‘pick up the bill,’ there are limits to the extent to which the private sector can be shielded from this income shock,” Dirk Schumacher of Natixis said in a research note to clients.

“The fall in consumer confidence to record lows in recent months indicates that households are aware of these limits to public support. There is also growing evidence that companies in energy-intensive sectors are reducing output.”

Quantitative tightening

Due to 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 part of recent comments from ECB officials is that the hiking cycle will be less sensitive to recession than we thought,” Deutsche Bank chief economist Mark Wall said in a research note.

“We raised our terminal rate forecast by 50bp to 2.5%,” he added. The ECB’s benchmark interest rate is currently zero.

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The Frankfurt institution believes its “neutral” interest rate – an optimal level for a stable economy – is between 1% and 2%, and with inflation risks rising, the ECB’s Governing Council may have to consider raising rates above this level into tightening territory.

Of course, it also raises the question of quantitative tightening – which is the technical description for shrinking the central bank’s balance sheet. Asset sales have not yet been discussed by the ECB.

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

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