The ECB is trending towards a historic rate hike

“We expect a rate hike of 75 basis points,” explains Franck Dixmier, director of bond management at Allianz Global Investors, explaining the shift in the consensus of the observers, who had originally expected a key rate hike of 50 basis points. Such an increase would be a first for the monetary institute in its two decades of existence.

“Given the level of inflation and the uncertainty about future price developments, there is less risk for the ECB to do more than less,” says Franck Dixmier. In July, it had a firm hand announcing a surprise 50 basis point raise when 25 points were expected.

Also read: The ECB condemns cracking down on inflation

This first surge in more than a decade came after a long period in which easy money helped boost the economy. The guardians of the euro have thus suddenly ended eight years of negative interest rates by lowering the interest rate on bank deposits at the ECB from -0.5% to 0%.

preserve purchasing power

The promise then was to do the same in September provided inflationary pressures persist. However, the opposite happened. Prices rose 9.1% over a year in the euro zone in August, the highest since the launch of the single currency. Inflation is thus well above the rate of 2% targeted by the ECB.

The new tensions in energy prices since the complete halt to Russian gas supplies to Europe mean that double-digit inflation can even be expected in the autumn. In this simmering context, what remains within the ECB are a fraction of policymakers who still defend the “gradual” approach to rate hikes, led by chief economist Philip Lane.

But this clan “is in the minority,” notes Bruno Cavalier, economist at Oddo. The weakness of the euro, which fell below the $0.99 threshold on Monday, provides another argument for a monetary policy hit. A weak euro increases the cost of imported products, fueling inflation.

Finally read: Is the franc too strong again?

At the end of August, Isabel Schnabel, an influential member of the Executive Board, hammered to the ECB that the only possible way was that of “determination” in the face of unbridled prices and this “even at the risk of weaker growth and higher unemployment”. The dilemma between rising prices and recession fears has held back ECB action over the past year, while other major central banks have embarked on a cycle of rate hikes.

But if a central bank is slow to adjust policy, “the costs can be significant,” conceded Isabel Schnabel, acknowledging that the ECB had believed for too long that the inflation shock would be temporary. However, the public must “maintain confidence in our purchasing power maintenance”, demanded Isabel Schnabel.

winter recession

Federal Reserve interest rates are between 2.25% and 2.50% and a 75 basis point hike is threatened on 21st September. For the ECB, which rates between 0% and 0.75%, the tweaking should continue “until rates reach a more ‘neutral’ level of between 1% and 2%,” said Frederik Ducrozet, Pictet’s chief economist wealth management.

Also read: The new inflation record in the euro zone in August is putting the ECB under pressure

An interest rate is said to be neutral if it neither stimulates nor slows down the economy. The ECB will come out with fresh economic forecasts on Thursday at a time when most institutions see the euro zone entering a recession this winter.

“We could be heading for one of the most difficult winters in generations,” warned EU Economic Commissioner Paolo Gentiloni on Wednesday. The problem is that an aggressive interest rate policy by the ECB will tighten credit conditions in eurozone countries like Italy that are deemed vulnerable.

Sooner or later, the institute will probably have to resort to its new tool, which was presented this summer to nip speculative attacks on debt in the bud, according to Holger Schmieding, economist at Berenberg.

Read again: The near-impossible mission of the ECB

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