The Business Times

ECB seen sending rates to higher peak in face of recession risk

Published Fri, Oct 21, 2022 · 02:04 PM

THE European Central Bank (ECB) will act much more forcefully than previously anticipated to rein in record inflation, even as the eurozone succumbs to a recession, according to a survey of economists.

The ECB’s deposit rate is expected to reach 2.5 per cent by next March, more than the 1.5 per cent foreseen in an earlier poll. That advance includes a 75 basis-point hike on Oct. 27, and another 50 basis-point step in December.

More than two-thirds of respondents said officials remain behind the curve in battling price gains that are just short of five times their 2 per cent target.

The survey suggests that a downturn in the 19-nation euro-area economy won’t prompt a halt in rate increases, whose ferocity has begun to match that of the Federal Reserve, despite kicking off four months later.

But the results also flag a concern that the ECB could eventually overshoot, forcing it to backtrack: One analyst said rates could be cut as early as July, though the median forecast is for the first reduction to come in 2024.

“With the looming recession, recent market turmoil in the UK and increasing financial risks, the ECB will have to tread very carefully,” said Carsten Brzeski, an economist at ING. “It will have to balance between blind determination to fight inflation and a premature pivot.”


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Determining the ideal dose of monetary tightening will be perilous. While soaring prices must be tackled, rate hikes are starting to weigh on households and companies already braced for a jump in winter energy costs and even potential shortages.

On the euro area’s border, Russia’s war in Ukraine - responsible for much of the uncertainty - could yet turn nuclear.

Some officials want rates to reach the so-called neutral level that neither stimulates nor restrains the economy - thought to be somewhere near 2 per cent - before assessing how much further to push.

“Inflation will remain uncomfortably high during the coming months, before falling sharply later next year,” said Nerijus Maciulis, an economist at Swedbank. “Against this backdrop, the ECB is very likely to tighten too much.”

Aside from rates, a debate is unfolding on when to begin shrinking the 5 trillion euro (S$7 trillion) stash of bonds the ECB acquired during recent crises - a process known as quantitative tightening (QT).

While most economists expect QT to start by the third quarter of 2023, the majority doesn’t see the ECB being able to roll off more than 30 per cent of its holdings - highlighting the danger of blowouts in bond yields of some euro-area governments.

Just over half said the ECB is likely to use its Transmission Protection Instrument - a tool unveiled in July to deal with unwarranted market turbulence - sometime in the next 12 months.

More details on QT may come in December, according to Luca Mezzomo, an economist at Intesa Sanpaolo, forming part of what he calls a “broad-based restriction of monetary policy despite an almost-certain recession”.

More immediately, 62 per cent of economists expect an announcement in October on changes to how some of the short-term cash commercial lenders hold at the ECB is compensated.

As rates are lifted, banks are enjoying an easy return on their excess liquidity - some of which stems from cheap, long-term funding provided by the ECB to boost credit.

Tougher terms on those loans are likely to eat into banks’ profits, though inflation remains the top risk to Europe’s outlook, according to survey respondents.

Governing council member Gabriel Makhlouf warned this week that some second-round effects on wages are likely from surging prices, while his colleague, Joachim Nagel, said inflation will ease only gradually over the coming year.

“The ECB is not nearly done with its inflation fighting,” said LBBW’s Elmar Voelker. “Further monetary-policy tightening will be necessary in the next meetings.” BLOOMBERG



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