In retrospect, we can say that central banks used the annual Jackson Hole symposium to revive their credibility as inflation fighters. This also applies to the ECB.
After yet another higher-than-expected inflation rate - we are now at 9.1 percent - and core inflation at a new record of 4.3 per cent, the ECB Governing Council on Thursday has adopted a record interest rate hike of 75 basis points.
If the economy does not collapse immediately, there will probably be another big rate hike of at least 50 basis points in October. But whether the ECB will still be raising rates in December remains to be seen.
Then comes the recession
The chance that the Eurozone will not fall into recession seems almost zero. That means that if the ECB continues to raise rates, it will exacerbate the contraction. It is rare for a central bank to happily continue tightening during a recession.
Moreover, a recession is not the only thing the ECB will have to worry about. It is now clear that huge support packages are needed to help households cope with the mega-rises in energy prices. On her first day as UK Prime Minister, Liz Truss, spent 170 billion pounds fighting the energy crisis. That is more than 5 percent of the UK’s GDP. In Germany, we are now at 100 billion euro.
The bailouts
That’s not all. Not only because it is not enough to compensate for increasing costs, but also because there are some more collapsing energy companies. Due to extreme volatility in the energy markets, energy companies are facing a huge increase in the margin they have to hold for their derivatives. That money is not there, with the result that they go bankrupt. To avoid further disruption of the energy supply, especially now that Russia has completely cut off the supply, governments need to keep these companies afloat.
Debt sustainability
Like every crisis of the past 15 years, the solution to the problem is more debt. Where else have we seen a recession with rising government debts? It seems unlikely that the ECB will continue to raise interest rates in such a situation. Moreover, investors are more than willing to test the ECB on when to deploy its new liquidity toy, the Transmission Protection Instrument.
Chart
Still, investors believe the ECB is going to hold out for a long time. Markets expect the ECB to raise interest rates until at least July next year. Moreover, that is months after the Federal Reserve will have stopped. When the ECB pauses - I don’t think they start cutting rates right away - that is a big difference from what the market thinks will happen. I leave it to you to decide what goes down first in that case.
Jeroen Blokland is founder of True Insights, a platform that provides independent research to build diversified multi-asset portfolios. Blokland was most recently head of multi-assets at Robeco. His “chart of the week” appears every Monday on Investment Officer Luxembourg.
This column originally appeared on InvestmentOfficer.nl.