‘Shock and awe’ move sees ECB hike rates by unprecedented 75bps

As hawkish central bankers prioritise tackling inflation over protecting growth

The European Central Bank decided to hike its three key interest rates by 75bps on Thursday, in a move that has been described as a “hawkish message”.

From 14 September, the interest rate on the main refinancing operations, marginal lending and deposit facilities will rise to 1.25%, 1.5% and 0.75%, respectively.

The central bank’s governing council said: “This major step frontloads the transition from the prevailing highly accommodative level of policy rates towards levels that will ensure the timely return of inflation to the ECB’s 2% medium-term target.”

It expects to “raise interest rates further to dampen demand and guard against the risk of a persistent upward shift in inflation expectations”.

Looking ahead, the ECB has significantly revised up its inflation projections and now expects to average 8.1% in 2022, 5.5% in 2023 and 2.3% in 2024.

“The hawks are definitely in control,” says Charles Hepworth, investment director at Gam Investments, after the ECB delivered what he described as “[a] ‘shock and awe’ sized cut which seems in vogue amongst central bankers at present”.

He adds: “From accepting the transient inflation narrative of last year, the policy reversal is almost as extreme as its outlook for growth—and inflation—this year, where it sees an improving outlook for GDP compared to their last assessment, with GDP growth for 2022 upgraded to 3.1% from the 2.8% prior estimate, and inflation at 8.1% this year compared to 6.8% previously forecast.”

More hikes on the cards

Concerns about the potential impact of higher-for-longer headline inflation on the euro and core inflation were the main drivers behind the ECB’s move, says Algebris Investments’ co-portfolio manager Gabriele Foà, who described the move as a “hawkish message”.

“Inflation projections were revised substantially to the upside, to 8.1% in 2022 and 5.5% in 2023. Recent increases in gas prices imply a higher level and later peak for European inflation.”

He adds: “The market is now pricing the terminal rate close to 2.25%, but the ECB may decide to turn more hawkish in subsequent meetings and keep the pace of hikes elevated. As such, we expect further upside to the number of hikes currently being priced by markets.”

Bleak winter ahead

“Stuck between a rock and a hard place, ECB policymakers felt they had little option but to go ultra-big with the rate rise to try and cut the rope on inflation and spark a fall from its ascent,” says Hargreaves Lansdown senior investment and markets analyst Susannah Streeter (pictured).

“But it couldn’t come at a worse time with Russia’s gas taps to Europe turned off in retaliation for punitive economic sanctions. With energy prices so elevated, bringing an end to the price spiral is going to be far from easy, and the ECB is warning that fresh hikes will be on the way. Business and consumers will be faced with the double whammy of higher borrowing costs and worries about energy security, accelerating the prospects of recession and setting the scene for a bleak winter ahead.

“The latest fall in the US jobless claims numbers to a three-month low is likely to strengthen the mighty dollar even further, as it underlines the resilience in the American economy, and adds to expectations that the Fed will also step on the pedal of rate rises. This has piled further downwards pressure on the euro, which looks set to head back below parity with the dollar, raising fresh inflationary concerns as it’ll make imports that bit pricier.”

Inflation a bigger problem than stagnating growth

Candice Bangsund, vice president and portfolio manager of global asset allocation at Fiera Capital, described the 75bps hike as “outsized”.

“Policymakers have clearly prioritised tackling persistently elevated inflation, regardless of the economic fallout. The European Central Bank is in a precarious position as policymakers attempt to rein-in record-high inflation even in the wake of a deteriorating economy and as recession risks loom large.

“Indeed, the new forecasts revealed that both the growth and inflation outlooks have worsened, with the 2023 growth forecast slashed to 0.9% from 2.1% in the prior forecast, while inflation forecasts were revised broadly higher through 2024.”

Rupert Thompson, investment strategist at Kingswood, concurs: “The ECB […] is very much prioritising getting inflation back under control even as the economy looks headed into recession later this year.

“This move can only add to the pressure on the Bank of England to follow suit with a 0.75% rise next week, particularly with the news today of the government’s large-scale intervention to cap household and business energy bills.”

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