European Central Bank Commentary September 2022

Updated September 8, 2022

The European Central Bank meets on Thursday amid a loud cacophony of hawkish rhetoric from ECB officials over the past few weeks. Numerous governing council members have advocated a jumbo-sized 75-basis point rate hike to combat rocketing inflation, which would be the biggest since 1999. But a shock-and-awe move by the historically sedate ECB would come in the face of economic data suggesting the eurozone is on the verge of a recession.

The intensifying energy shock in Europe signals a harsh winter ahead for businesses and households. Governments across the continent are scrambling to announce new measures to tackle rising prices. It follows that any support that limits falling growth also frees the ECB’s hand to tighten policy further. But do policymakers front-load rate hikes to take out the risk of energy price rises severely impacting economic activity and incomes?

Market expectations have reacted to the recent hawkish noise by pricing in nearly 175 basis points worth of tightening through the remainder of the year. This equates to the equivalent of a 75-basis point move on Thursday and then two further half-point rate hikes in October and December.

We are now in a monetary policy world where central banks are increasingly sensitive to inflation and proving their credibility in fighting price pressures. This means the ECB must meet those market expectations to underpin support for the euro, as it dallies with the mystical parity level. Traders will focus on any signs that the bank will continue with an aggressive rate hike cycle, even though economic risks are mounting heading into the winter. The new staff projections will also be of interest as they will no doubt approach the ECB’s downside risk scenario of higher inflation and slower growth.

Bank of England Meeting Review

The ECB revealed its hawkish side by raising interest rates by 75 basis points to tackle record high inflation. This was biggest hike since 1999 and comes after the bank lifted the deposit rate in July for the first time in more than a decade. Markets had priced in a 75% chance of this move before the meeting, but many economists believed policymakers would only lift rates by a half a percentage point, similar to the move two months ago. The bank had never hiked by more than 25bps between 2000 and July 2022.

The statement said that over the next several meetings, the ECB expects to raise rates to dampen demand and to guard against the risk of a persistent upward shift in inflation expectations. It will regularly evaluate policy path which tallies with its recent shift to a data dependent, meeting-by-meeting approach.

The bank painted a tough picture on inflation forecasts and a still optimistic growth outlook in its latest staff projections. But inflation estimates may be too low with the widely watched 2024 number revised higher only to 2.3% from the 2.1% projection in June. That said, the validity of these upward inflation revisions depends on what the EU does on capping energy bills, which we may see at tomorrow’s summit.

President Lagarde revealed the decision was unanimous which means the doves’ influence on the Governing Council may be diminished. There is speculation that this was likely the result of some sort of compromise to not discuss quantitative tightening. But it is clear President Lagarde has rolled up her white jacket sleeves to fight rampant inflation. She even implied this may take three to five meetings, so traders are speculating that we get rate hikes through until February.

Written by Jamie Dutta, Market Analyst for Vantage

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