Goldman Sachs expects the European Central Bank to raise interest rates by 75 basis points at its meeting next week after data showed, on Wednesday, that inflation in the euro area hit a new record high.
“Given the stronger-than-expected inflation data released today – as well as hawkish comments and higher risks to short-term growth – we now expect the (EC) Executive Board to raise interest rates by 75 basis points at the September meeting, the US investment bank said in a note today. /September”.
The bank’s economists also raised the peak they expect European interest rates to reach by February 2023 to 1.75 percent, from 1.50 percent in their previous estimates.
The European Central Dilemma
Eurozone inflation has soared to a new record and will soon hit double digits, suggesting a series of big interest rate increases even as a painful recession becomes increasingly certain.
Consumer prices jumped more than expected in August, driven by rising gas prices as well as a devastating drought, and there are other hikes expected, adding to the suffering of families and businesses, as inflation simply eats up their cash reserves.
This synchronization of high prices and low growth, often referred to as stagflation, leaves the ECB with only dire choices that will add to the suffering of the eurozone’s 340 million people.
What makes the situation even more difficult for the bank is that the stimulus and easing monetary policy that it may take will only increase inflation and ultimately damage its credibility, threatening the foundations of its anti-inflation mandate.
However, monetary tightening will slow growth further, leading to an almost certain increase in the pace of the economic downturn from the start of the heating season in October.
Ultimately, ECB policymakers will choose to fight inflation and, in an effort to curb it, will likely raise interest rates at every meeting remaining this year, raising borrowing costs for governments, businesses and households, even with finances already tight.
Indeed, today’s inflation numbers will only make the case for a very substantial 75bp rate hike by the European Central Bank next week, and monetary easing will have to fight an uphill battle to bring the hike down to 50bp, which is still a significant pace.
Inflation accelerated
Inflation accelerated in the 19 countries that share the European single currency to 9.1 percent in August from 8.9 percent the previous month, exceeding expectations again as price pressures increased.
“Inflation is likely to jump in September… Thus, the pressure on the European Central Bank to continue raising interest rates significantly is likely to remain high,” said Christoph Weil, an economist at Commerzbank.
While the rise in food and energy prices was not surprising, the jump in services costs and the five percent inflation in the prices of non-energy industrial goods will obviously worry ECB policymakers.
They will also be concerned about the continued rise in prices in other related sectors, indicating that higher costs are now spreading to the entire economy, through so-called “second round” effects.
Excluding food and fuel, inflation accelerated to 5.5 percent from 5.1 percent while a narrower measure, which also excludes alcohol and tobacco, rose to 4.3 percent from 4 percent.
“We now expect the European Central Bank to raise (interest rate) 75 basis points next week,” Nordea Financial Services Group said in a note.
Recession
In light of the above, avoiding deflation is becoming increasingly difficult, as economic sentiment appears to be lower than expected this month, highlighting growth concerns.
Higher energy costs will force households to direct their spending toward the heating bill, leaving fewer resources for other spending, especially services.
The industry will also be severely affected, as the energy-intensive sectors are likely to reduce production. This will subsequently lead to a shortage of supply, which will increase inflation.
“Rising inflation will put more pressure on demand, depressing growth and pushing the eurozone into recession this winter,” said Riccardo Marcelli Fabiani of Oxford Economics.
Capping energy prices, as the European Union thinks, could help the ECB with its mission, but inflation is already so high and has been for a while, so policymakers will not have the luxury of avoiding the storm.
(Archyde.com)