Rates, the ECB’s dilemma between inflation and recession

Tackle the problem of inflation but with a high risk of recession in the Eurozone or take a more cautious approach but with the danger of a further weakening of the Euro. The dilemma faced by the ECB at the meeting of the Governing Council has many ‘faces’, which with an expected rate hike of 50 points (but more likely 75) will bring them all back to positive after many years. A decision that comes after those of all the other major central banks, which in turn are decidedly aggressive in the tightening of their respective monetary policies. For Sylvain Broyer, Chief Economist EMEA at S&P, after lagging behind the Fed, “the ECB needs to do much more on rates, as short-term inflation outlook continues to deteriorate, while activity and the market of the work remain quite resistant. At a minimum, to return to neutral territory, monetary policy would have to increase the deposit rate by 100 basis points compared to the current one ”. Broyer recalls that some Board members are taking baby steps logic, as “increasing the deposit rate by 50 basis points this week, while increasing the repo rate and the marginal lending rate by 75 basis points, could contribute to further normalize monetary conditions without upsetting the financing conditions too much. “According to Frederik Ducrozet, of Pictet Wealth Management” after the ‘hawkish’ turn in Jackson Hole, a 75bp rate hike is likely in September and the ECB is unlikely to surprise in a dovish sense: the main objective of the ECB will be to anticipate monetary tightening, regardless of the interruptions, until rates reach a more “neutral” level, between 1% and 2%. But let’s continue to believe that the ECB will suspend its cycle of hikes in a recession that appears more severe every day, even if the normalization of policies could resume later , in 2023 “. For Gergely Majoros, member of Carmignac’s Investment Committee,” the situation that the ECB is facing has become very delicate. Given the recent signs of a rise in inflation data beyond the pressures on energy prices and the significant weakening of the euro, which is inherently inflationary, we believe that the likelihood of a 0.75% rate hike for the next ECB meeting has increased significantly. The main question, however, is whether the ECB will indicate a change of strategy for the remaining meetings this year ”. “As the ECB is keen to close the gap separating it from neutrality as quickly as possible, we believe an acceleration of interest rate hikes to 75 basis points at a time is highly likely. Rate hikes could in fact be much more difficult to achieve in 2023, due to the potentially recessive context, the overcoming of the inflation peak and the pause in the US Fed’s hike cycle ”. Evaluating the possible choices of Frankfurt, Ebury analysts observe that “last Friday’s announcement by Gazprom that it would close the Nord Stream 1 gas pipeline” indefinitely “not only induces a clear downside risk for the economy, but it represents an additional motivation to take a slightly more cautious approach to tightening policies. We expect this to be reflected in a series of more dovish communications from President Lagarde, a downward revision of this month’s GDP forecast for 2022, and an admission that a mild technical recession may be on its way to the area. euro at the end of 2022 or the beginning of 2023. That said, we believe that the size of the increase will be widely debated among policy makers. Some ECB members have already expressed concerns about a faster pace of monetary policy normalization, including chief economist Lane, who last week called for a ‘steady pace’ of interest rate hikes. We recognize the merit of this argument, in particular the risk of greater fragmentation and the possibility that the bank may be forced to activate its protection instrument (TPI). However, we believe that the risk of letting inflation get out of control is too high and that most members would agree with this assessment. ”From eToro analyst Gabriel Debach explains that“ money market futures they do not believe that the “accommodative” position will prevail, pricing what would be the largest increase in the ECB, together with further increases of up to 2% by February ”even if“ the impact of the decision on the fight against inflation remains uncertain. It will certainly increase the risks of recession, already high in Europe, but it will allow us to take advantage of any support policies, rate cuts, in this future scenario. Filippo Diodovich, Senior Market Strategist IG Italia, recalls how “the latest inflation figures for August (at 9.1% per annum) have increased the likelihood of a very significant increase that has led some insiders to think about an increase by 100 basis points on the pressures of Eurozone countries with a consumer price index at astronomical levels (such as the Baltic countries above 20%, Estonia at 25.2%, Lithuania 21.1% and Latvia 20.8%) “. “It is clear – he observes – that within the Board of Directors there are very different opinions” with some ‘soft’ attitudes such as that of the chief economist Philip Lane and the member of the ECB Board of Directors, the Italian Fabio Panetta, “who had supported a softer attitude on the rise in rates to avoid bringing the countries of the Euro Zone into recession. “” Our expectations are set for a rise by the European Central Bank of 75 basis points “because – he adds – the Eurotower “It must show, in our opinion, a hawkish attitude, to avoid that the Eurodollar exchange rate could show further bearish accelerations as this entails further growth pressures on prices”. Finally, Claudia Fontanive-Wyss and Mondher Bettaieb-Loriot recall that “the market is heavily pricing in a 75 basis point rise for tomorrow’s meeting, reinforced by hawkish comments from various ECB members in recent days. Only Philip Lan and he seems to have some reservations, advocating a more measured approach. We would like to see a 75bp hike, as we believe the data is in favor of immediate rather than late action, while we don’t entirely rule out the possibility of a 50bp hike. “