Higher rates, more pain ahead for Europe

The European Central Bank is set to raise interest rates by 0.75 percentage points on Thursday, joining its global peers in pushing borrowing costs up more quickly than has been seen in decades.

  • But Europe’s economic predicament is distinctly different from that of the United States, which creates a heightened risk the ECB will cause excessive pain in a continent already reeling from the war in Ukraine.

Why it matters: Amid concerted monetary tightening by the world’s leading central banks, the risks of a global recession are high. The ECB appears determined to be part of the rate-rising push, despite an inflation problem rooted in geopolitics rather than too much demand.

Driving the news: The ECB governing council meets Thursday in Frankfurt and is expected to enact its second straight three-quarter-point rate increase, pushing a key deposit facility rate — which was negative 0.5% as recently as July — to 1.5%.

  • The policy announcement is at 8:15am EDT, followed by a press conference by ECB president Christine Lagarde set for 8:45 EDT.
  • It has already drawn an attack from Italian prime minister Giorgia Meloni, who said today the action was “considered by many to be a rash choice, which runs the risk of impacting banking credit to families and businesses,” according to Bloomberg.

State of play: There is ample evidence of too much demand in the U.S. amid a super-tight labor market and strong consumption spending. The Fed, with its rate hikes, is trying to bring demand down to match supply.

  • Europe’s price pressures are more rooted in the massive surge in energy costs resulting from Russian retaliation for European support of Ukraine, a negative supply shock.

So why is the ECB aggressively tightening policy anyway? Leaders of the central bank see a risk that current high inflation will become entrenched, especially as crucial bargaining over wages plays out in Germany and other Eurozone economies in the final months of 2022.

  • The ECB is built on the DNA of the hard-money, inflation-phobic German Bundesbank. It seeks to head off the risk that this year’s high prices lead to a surge in wages next year, creating self-perpetuating inflation.
  • Moreover, central bank leaders stress that they are only seeking to bring rates toward a neutral level that neither stimulates nor slows the economy, meaning something like 2.5%. The Fed is pushing U.S. rates well abovethat level to actively slow the economy, toward 4.5% or beyond.
  • The ECB also benefits from the Fed’s more aggressive action, because if the Fed successfully slows demand in the United States and the rest of the world, it will mean lower energy prices and fewer supply strains in the Eurozone.

Yes, but: The Italian prime minister’s comments are only the beginning of the heat the ECB will take as Europeans face a winter of soaring prices and rising borrowing costs that make the economic pain worse.

Πηγή: axios.com

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