In light of the numerous hawkish comments and sources stories during the weekend, we now change our ECB rate call.
We now expect ECB to hike 75bp next week, which will be followed by 50bp in October and 25bp in December, but acknowledge the increased uncertainty on the two latter hike size expectations. This is +25bp for our previous rate hike expectations at both the September and the October meetings, respectively, and we now see the end-point of the ECB deposit rate at 1.5%.
As regards the reinvestment schedule, we currently do not foresee that ECB will change it, but increased market and ECB focus in
We believe the euro area will face a recession and ECB will hike into that, however, we also acknowledge that even without the ECB tightening, the European economy was in a severe situation to begin with a worsening energy crisis.
Intensifying inflation pressure – hawks are on the wires
The European economy is facing a large supply shock on the back of spiralling gas and electricity prices in the past couple of weeks. As a result, we have seen a significant intensification of the near-term inflation pressure, with the inflation peak now projected by markets above 10% in December (compared to an expected inflation around 9% in September for most of Q2). As a result of the intensifying inflation dynamics we have also seen increased volatility and uncertainty around this. This has lead the particularly hawkish members of the ECB’s Governing Council to be very aggressive and argue for a sharp tightening need in the past couple of days. They also point to increased risks of inflation expectations becoming de-anchored or a wage/inflation spiral kicking in.
Important speech by Schnabel
During the Jackson Hole conference this weekend, the influential ECB member Schnabel outlined a very hawkish presentation, when she shared her view of the economy and inflation outlook. While Schnabel argued for a new era of volatility, with a less favourable environment where shocks are potentially larger, more frequent and persistent, she also recalled that the ECB has a price stability mandate, which may be controversial in an environment of elevated uncertainty and structural change in economic dynamics. However, she argues that in certain circumstances stabilising inflation is no longer equivalent to stabilising output during shocks and therefore implies a trade-off for monetary policy, between inflation and output. Furthermore, Schnabel said that central banks can take two paths: either 1) ‘caution’, in line with the view that monetary policy is the wrong medicine to deal with supply shocks or 2) ‘determination’ with a forceful response to inflation even at the risk of lower growth and higher unemployment.
