ECB will raise rates to higher levels despite the threat of recession

A recent survey of economists has showed that, according to their opinion, the European Central Bank (ECB) may start to act more decisively than it was expected in order to take a record-high inflation under control. These actions have to be taken even under the threat of recession in the eurozone.

At this moment, it’s expected that the ECB’s deposit rate will be about 2.5% by March next year, including its increase by 75 basis points at the bank's next meeting on October 27 and another 50-basis-point increase in December. Previously, economists suggested a rate hike of only 1.5%.

Thus, recession in the euro zone economy isn’t likely to stop further monetary policy tightening. However, there is a certain risk that the ECB may cross the limits of accessible increase in interest rates, which eventually would force it to abandon its current strategy. Among the analysts participating in the survey, there was an opinion that the rates might be reduced by next summer. For example, according to Swedbank economist Nerijus Maciulis, inflation will remain extremely high in the upcoming months, but then it will decline sharply next year. Joachim Nagel, in turn, said that the decline in inflation will happen gradually over the following year. Overall, most economists believe that the rate cut probably won’t occur until 2024.

According to Carsten Brzeski, an economist at ING, the ECB should act extremely cautious due to the looming economic recession, growing financial risks and recent market turmoils.

Elmar Voelker of the LBBW declared that the ECB will need to continue the monetary policy tightening within its future meetings because the fight against inflation is far from being over.

Some of the central bank’s representatives consider that the interest rate should be brought to a so-called neutral level, which neither stimulates nor restrains the economy, in order to determine the way of forward actions. Usually, a rate of 2% is considered to be neutral.

Also, now the ECB faces the question about reducing its bonds acquired during the recent crises to a total amount of 5 trillion euros ($4.9 trillion).

Most experts assume that the ECB will start the reduction in the third quarter of 2023, but it’s important to note that, in their view, the ECB won’t be able to get rid of more than 30% of its assets. More details about the ECB's asset balance reduction could come in December, according to Luca Mezzomo, an economist at Intesa Sanpaolo.

It’s highly likely that over the next year, the ECB will use its Transmission Protection Instrument developed in July to deal with unwarranted market turmoils.

However, Governing Council member, Gabriel Machluf, identified another consequence of monetary policy tightening, which is a potential negative impact of rising prices on wages.