With inflation in the euro zone projected to rise to at least 10% in the coming months, a “jumbo” rate hike of 75 basis points is certainly a possibility.

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FRANKFURT, Germany — The European Central Bank is expected to undertake a series of rate hikes and sacrifice growth in the region as rising costs of living threaten to soar even higher.

ECB Executive Board Member Isabel Schnabel’s Speech at Jackson Hole set the tone for the upcoming policy meeting this week. With inflation in the euro zone projected to rise to at least 10% in the coming months and the risk of consumer prices skyrocketing higher, a “jumbo” 75 basis point rate hike on Thursday is certainly a possibility.

“Since an advance up front could have a bigger impact on inflation expectations than a more gradual approach, a 75bp move could make sense,” ECB analyst and Berenberg Chief Economist Holger Schmieding said in a research note.

“While mostly priced in, it could still exacerbate tensions in the bond market.”

The recent halt to gas shipments to Europe via the Nord Stream 1 pipeline not only pushed stockpiles lower and increased the risk of a recession in Europe, but also pushed the Italian government’s 10-year yield to 4% — the highest level since mid-June. before the ECB announced the creation of an anti-fragmentation tool. High yields for Italy – much higher than in Germany – mean the government in Rome has had to pay more to borrow, exacerbating concerns over a hefty debt pile.

Inflation in the euro zone hit 9.7% in August and with continued pressure on energy prices, it is expected to hit double-digit levels in the coming months. At the same time, the risk of a recession looms over the region’s economy as consumers feel sick and reduce their consumption, and companies struggle with high energy prices.

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“While the government will partly ‘pay the bills’, there is a limit to the extent to which the private sector can be protected from this revenue shock,” Dirk Schumacher said with Natixis in a research note to clients.

“The drop in consumer confidence to a record low over the past few months suggests that households are aware of these limitations in light of government support. There is also growing evidence that companies in the energy-intensive sector are cutting back on production.”

Quantitative tightening

Due to the inflation outlook, the ECB is expected to sacrifice growth to keep inflation expectations anchored, as this is the bank’s core mandate.

“The key takeaway from recent comments by ECB officials is that the upside cycle will be less recession sensitive than we thought,” Deutsche Bank Chief Economist Mark Wall said in a research note.

“We raised our terminal rate forecast by 50bp to 2.5%,” he added. The ECB’s benchmark interest rate is currently at zero.

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The Frankfurt Institute believes the “neutral” rate – the optimal level for a stable economy – is between 1% and 2% and with inflation risks rising, the ECB’s Governing Council may need to consider raising interest rates above that level to tight territory.

That, of course, also raises the question of quantitative tightening — which is the technical description of shrinking the central bank’s balance sheet. The sale of assets has not been discussed by the ECB.

“Given the threat to the ECB’s credibility, we also wonder why quantitative tightening is not discussed,” said Anatoli Annenkov of Societe Generale, in a research note. “Not using QT should imply higher rates.”

By Blanca

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