As the cost of living rises and threatens to climb much more, the European Central Bank is expected to speed a series of rate hikes, compromising regional growth.
The Jackson Hole speech by ECB Executive Board Member Isabel Schnabel set the tone for this week’s policy meeting. With European inflation anticipated to reach at least 10% in the next months and consumer prices certain to surge, a “jumbo” 75 basis point rate rise on Thursday is unquestionably a possibility.
The recent halt in gas deliveries to Europe via the Nord Stream 1 pipeline has not only pushed stocks lower and increased the risk of a European recession, but it has also pushed 10-year Italian government bond yields to 4%, the highest level since mid-June, before the ECB announced the creation of an anti-fragmentation tool. Because Italian rates are substantially higher than those in Germany, the Italian government must pay more to borrow, aggravating concerns about the country’s large debt.
With persistent pressure on energy costs, eurozone inflation is expected to reach double-digit levels in the coming months. Simultaneously, the risk of a recession hangs large over the region’s economy, as individuals feel the squeeze and cut down on spending, while companies battle with rising energy prices.
The ECB is likely to sacrifice growth in order to maintain stable inflation expectations, given this is the bank’s principal goal.
The fundamental rationale for aggressive action is that it would send a strong signal of the ECB’s unwavering commitment to price stability after months of underestimating price pressures. Sending such a signal would lessen the risk of undermining inflation expectations and necessitating even more aggressive tightening in the future.
A more conservative 50-basis-point plan is thought to keep the ECB from having to reverse policy, as it did in 2008 and 2011, despite the increased likelihood of a recession. A “multi-step adjustment strategy… makes it easier to execute mid-course alterations if circumstances change,” according to ECB senior economist Philip Lane.
