The European Central Bank met on Thursday amid a loud cacophony of hawkish rhetoric from ECB officials over the past few weeks. Numerous governing council members have advocated a jumbo-sized 75-basis point rate hike to combat rocketing inflation, which would be the biggest since 1999. But a shock-and-awe move by the historically sedate ECB would come in the face of economic data suggesting the eurozone is on the verge of a recession.
The intensifying energy shock in Europe signals a harsh winter ahead for businesses and households. Governments across the continent are scrambling to announce new measures to tackle rising prices. It follows that any support that limits falling growth also frees the ECB’s hand to tighten policy further. But do policymakers front-load rate hikes to take out the risk of energy price rises severely impacting economic activity and incomes?
Market expectations have reacted to the recent hawkish noise by pricing in nearly 175 basis points worth of tightening through the remainder of the year. This equates to the equivalent of a 75-basis point move on Thursday and then two further half-point rate hikes in October and December.
We are now in a monetary policy world where central banks are increasingly sensitive to inflation and proving their credibility in fighting price pressures. This means the ECB must meet those market expectations to underpin support for the euro, as it dallies with the mystical parity level. Traders will focus on any signs that the bank will continue with an aggressive rate hike cycle, even though economic risks are mounting heading into the winter. The new staff projections will also be of interest as they will no doubt approach the ECB’s downside risk scenario of higher inflation and slower growth.