The European Central Bank is expected to put aside recession worries and make another massive interest rate hike this week to calm inflation, as Russia’s war on Ukraine drives up prices for energy.
Inflation in the 19-nation eurozone hit a record high of nearly 10% in September, five times the ECB’s 2% target.
Last month, the ECB Governing Council raised its key interest rates by an unprecedented 75 basis points, and many observers expect it to reiterate its decision at Thursday’s meeting.
Households and businesses are preparing for a dark winter as Russia continues to cut gas supplies to Europe, raising fears of energy shortages and sky-high electricity and heating bills.
The war has also pushed up food prices, while pandemic-era supply chain issues, combined with higher manufacturing costs, have added to price pressures on a range of products. .
“Those who thought inflation was dead now know better,” said Joachim Nagel, the head of Germany’s central bank Bundesbank.
“Now the beast has woken from its slumber…it’s up to the monetary policymakers to tame it again,” he recently told students at Harvard University.
Like other central banks, the ECB is using a series of rate hikes to rein in inflation – at the risk of slowing economic activity to such an extent that it triggers a downturn.
“The 75 basis point rate hike appears to be a done deal,” said ING economist Carsten Brzeski.
“The ECB has turned a blind eye to the risks of recession,” he added.
Analysts at Capital Economics said they see the ECB going even further, predicting a jump of 100 basis points followed by smaller increases over the next few months.
“Not Painless”
In the United States, where inflation is at its highest level in 40 years, the Federal Reserve recently declared that there is no “painless” way to combat runaway prices.
A slowdown in economic growth and the US labor market will be “necessary” to bring inflation down, said the Fed, which raised rates faster and more aggressively than the ECB.
ECB President Christine Lagarde warned that the euro zone was also facing “a significant slowdown”.
If Russia completely cuts off gas flows to Europe, the eurozone economy could shrink by almost 1% in 2023, added ECB Vice President Luis de Guindos.
It’s a scenario that has become more likely after Russia halted gas flows through the crucial Nord Stream 1 pipeline to Europe’s biggest economy, Germany, in late August.
government spending
The German economy, whose energy-intensive industries relied heavily on Russian gas before the war, is now expected to contract by 0.4% in 2023.
Chancellor Olaf Scholz has unveiled a €200 billion energy fund to help people deal with price shocks, irritating European neighbors who cannot afford the same fiscal largesse.
As other eurozone countries such as France and Spain also roll out support measures, the ECB has warned governments not to fall into the trap of spending so much that they boost inflation.
German Finance Minister Christian Lindner agreed, saying last week that fiscal policy “must not counter central bank measures” by bolstering demand.
The ECB should also use this week’s meeting to discuss the alignment of other monetary policy levers with its inflation-fighting efforts.
Policymakers will likely consider modifying the super cheap long-term loans (TLTROs) offered to banks in recent years to help the euro zone through several crises – sometimes at negative rates.
Following the ECB’s rapid rate hikes since July, lenders can now make a profit by parking their excess TLTRO cash at the central bank and pocketing the new higher deposit rate – leaving the ECB to look for ways to encourage early repayment of loans. .
The ECB could also consider how best to shrink its balance sheet by trillions of euros, after years of sucking up government and corporate bonds to drive up stubbornly low inflation.
But given the uncertain outlook and the risk of rattling financial markets, analysts say the start of any “quantitative tightening” is still a long way off.
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