ECB needs to take control and raise interest rates to fight rising inflation

Autor: Article based upon analysis from Reuters Breakingviews | Link: ECB has reasons to avoid a panicky hike
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Captive between the perils of inflation and the impending risk of recession, the European Central Bank has taken a policy decision to continue increasing their key interest rates in the hope that prices, now rising at an annual 9% in the eurozone, will begin to slow down.

The question is how fast and how hard it should strike. With the risk of a serious economic slowdown next year, too big a hike next week would look like a panic attack. However, there is little debate that the ECB must act.

The view is that it has been rather late in its actions, the current inflationary effects caused by events across the EU, which has been propelled by volatile energy and food prices, should have been foreseen by its army of economists and think tanks, particularly with the volatility of the Russia/Ukraine situation.

But even taking these market effects into account, the core inflation was still at an annual 4.3% in August, far away from the ceiling of ECB’s official 2% target, and let’s not forget that the ECB interest rate has remained negative for eight years until July, and even today it still stands at 0%.

Isabel Schnabel, a member of ECB’s Executive Board has indicated that the ECB is leaning toward the hawkish side, saying that recession or not, now is the time to fight inflation “forcefully” and head on.

The analysts from Pictet are now expecting a 0.75% hike next week, after a 0.5% increase in July. The Money markets and the pricing from Refinitiv, strongly indicate that the ECB’s base rate will reach 2.3% next year.

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Their case is strengthened by the U.S. Federal Reserve, which has been even more aggressive in its response, raising rates faster and more robustly than the ECB, which has consequently weakened the Euro against the dollar, creating yet another source of imported inflation for the ECB to contend with.

Yet ECB Chief Economist Philip Lane has another view, he argues that small incremental steps are the best solution. Smaller regular increases would allow the central bank to adjust and fine tune its policy if the expected slowdown turns into an outright recession.

In this respect, regular, moderate hikes of 0.25% or 0.5% at each of the upcoming ECB meetings would smooth the consequences of clamping down on inflation as it reaches the end of the tightening cycle.

With the ECB likely to shrug off recession concerns, politicians will have to do more to fight a recession. But three years of crises, from the pandemic to the Ukraine war, have swollen government debt across the euro zone from 84% of GDP in 2019 to 96% in 2021 – and it is still rising. The costs of funding across the region are also continuing to rise, compounding an already bleak situation.

The major danger for Europe is that we could easily slip into a recession, in whatever shape it comes, without the usual fiscal cushion. For the ECB, overzealous hikes risk being followed by a messy retreat, as bold actions can have serious consequences.