ECB policymakers make the case for a big rate hike

Business

European Central Bank policymakers made the case on Saturday for a large interest rate hike next month as inflation remains uncomfortably high and the public may be losing trust in the bank’s inflation-fighting credentials.

The ECB raised rates by 50 basis points to zero last month and a similar or even bigger move is now expected on Sept 8, partly on sky-high inflation and partly because the U.S. Federal Reserve is also moving in exceptionally large steps.

Speaking at Fed’s annual Jackson Hole Economic Symposium, ECB board member Isabel Schnabel, French Central Bank chief Francois Villeroy de Galhau and Latvian central bank Governor Martins Kazaks all argued for forceful or significant policy action.

“Both the likelihood and the cost of current high inflation becoming entrenched in expectations are uncomfortably high,” Schnabel said. “In this environment, central banks need to act forcefully.”

Markets were betting on a 50 basis point move on Sept 8 until just days ago but a host of policymakers, speaking on and off record, now argue that a 75 basis point move should also be considered.

“Frontloading rate hikes is a reasonable policy choice,” Kazaks, said. “We should be open to discussing both 50 and 75 basis points as possible moves. From the current perspective, it should at least be 50.”

Rate hikes should then continue, the policymakers argued.

With rates at zero, the ECB is stimulating the economy and remains far from the neutral rate, which is estimated by economists to be around 1.5%.

Villeroy said that the neutral rate should be reached before the end of the year while Kazaks said he would get there in the first quarter of next year.

“In my view, we could be there before the end of the year, after another significant step in September,” Villeroy said.

Schnabel also warned that inflation expectations were now at risk of moving above the ECB’s 2% medium term target, or “de-anchor” and surveys suggested that the public has started to lose trust in central banks.

The rate hikes come even as the euro zone growth slows and the risk of a recession looms.

But the recession will be mostly due to soaring energy costs, against which monetary is powerless. The downturn is also unlikely to weigh on price growth enough bring inflation back to target without policy tightening, many argue.

The looming downturn is an argument to frontload rate hikes as it becomes difficult to communicate policy tightening when the slowdown is already visible.

“With this high inflation, avoiding a recession will be difficult, the risk is substantial and a technical recession is very likely,” Kazaks said.