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The European Central Bank’s hawks have a big chance this week to raise interest rates for the last time in months, and analysts are divided over whether they can seize the opportunity.
Whatever the ECB decides, there are potential pitfalls: Keeping interest rates steady will invite criticism that it is giving up too early in the fight against inflation, but raising them could make a looming recession worse. .
Ahead of Thursday’s knife-edge decision, Dutch central bank governor Klaas Nott said investors may be underestimating the likelihood of a rate hike, especially since persistently high wage growth remains “well below” the pace of interest rate hikes. ECB inflation fell to a level consistent with 2%. sub-goals.
Others, including Bundesbank President Joachim Nagel and Belgian Governor Pierre Wunsch, have also expressed these concerns.
“If there is no rate hike in September, the window will close,” said Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management. “GDP growth is on the verge of contraction and credit growth is slowing rapidly.”
Whatever happens, this week’s decision, considered the toughest since before the ECB started raising borrowing costs in July 2022, comes as the ECB lacks any signal on its next steps for the first time in years. Got to be trickier. Year.
The European Central Bank, led by President Christine Lagarde, has raised borrowing costs at its ninth consecutive policy meeting, raising its benchmark deposit rate from a record low of minus 0.5% to a record high of 3.75% as it pushes to contain the biggest coronavirus outbreak. financial crisis. Inflation soared in a generation.
More “dovish” members such as Portugal’s central bank governor Mario Centeno said the risk of “doing too much” has become “significant” as the euro zone’s economic outlook has worsened in recent weeks.
“I believe we are close to a level where we can stop raising interest rates,” Bank of Italy Governor Inazio Vesco said, citing indicators showing underlying inflationary pressures were falling.
Investors bets are on hold, with derivatives markets pricing in just a 35% chance that the European Central Bank will raise its deposit rate to 4% on September 14. Data last week showed a decline in business activity and a decline in German industry, reducing the likelihood of a rate hike. production and lowered second-quarter euro zone growth to 0.1% from 0.3%.
Eurozone inflation has halved since last year, falling to 5.3% in August. But it remains well above the ECB’s target, with upward pressure coming from higher oil prices and a weaker euro pushing up import costs, meaning another rate hike is still possible.
“I expect them (the hawks) to win and raise interest rates next week,” said Vito Constancio, a former deputy president of the European Central Bank. He predicted that inflation will remain high even if the euro zone stagnates. “Stagflation is coming in the eurozone, which should mean no other rate hikes for quite some time.”
The European Central Bank will also release new quarterly forecasts on Thursday, which may lower its economic growth forecast for this year and slightly increase its inflation forecast for 2023 and 2024.
The ECB was criticized last year for being too slow to raise interest rates after Russia’s full-scale invasion of Ukraine sent energy and food prices soaring. The Fed has been more responsive and inflation in the United States is now lower than in the euro zone.
“It would be bad if there was a pause while inflation is still at 5.3%,” said Ludovic Subran, chief economist at German insurance company Allianz. “Is it too early for the ECB to throw in the towel? ? For those worried about the stagflation narrative in Europe, this is eerie.”
Another reason the ECB continues to raise interest rates is concern that rapid wage growth will lead to high price pressures, especially for service companies where labor makes up the majority of costs.
Data released by the European Central Bank last week showed that the annual growth rate of per capita wages of euro zone employees in the second quarter was 5.5%, while unit labor costs rose by 6.4%, both close to historical highs.
“The hawks will be able to rely on data to support their stance,” said Klaus Westersen, chief euro zone economist at Pantheon Macroeconomic Research Center, adding that lower productivity could fuel inflation.
However, the economic outlook is increasingly grim, bank lending has slowed sharply and the euro zone labor market has begun to weaken. This all supports the dovish cause.
Core inflation – which excludes energy and food and is seen as a better gauge of underlying price pressures – appears to have peaked this summer. Prices are expected to fall further as economic activity slows and German public transport tickets, which were once discounted last summer, are compared this month with last year.
“What’s the point of tightening monetary policy?” said Dirk Schumacher, a former European Central Bank staffer now an economist at Natixis. “It’s about slowing economic growth. Well, that’s happening now.”
Some predict that as the ECB approaches peak interest rates, it may seek to tighten policy using other tools, such as shrinking its balance sheet faster through so-called quantitative tightening (QT), such as ending the €1.7 reinvestment earlier than expected. It began buying its tn bond portfolio during the pandemic.
Camille de Courcel, head of European rates strategy at BNP Paribas, said: “We expect the ECB to accelerate the QT process.”
Another option could be to cut the amount of interest paid by commercial banks or governments on deposits with the ECB.
Regardless of whether the ECB raises interest rates, Lagarde’s biggest challenge may be trying to convince markets that borrowing costs could still rise if inflation ends up staying too high.
Krishna Guha, a former Fed official and now vice chairman of U.S. investment bank Evercore-ISI, said: “The ECB is probably going to end in September anyway.”
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