After 50 bps hike, ECB has to lay groundwork for further rate hikes: Craig Erlam

“Central banks do not typically care about where the currency is. What they care about is the rate of appreciation or depreciation and what we have seen in the euro in particularly against the US dollar in recent months has been a rapid rate of depreciation and that will have factored into the policy making decision,” says Craig Erlam, Senior Market Analyst, OANDA.



How far would the 50 bps rate hike by the ECB help tame inflation and get consumption levels back on track because many would argue that this is a little more aggressive than what they were expecting the ECB to do?
Yes, I would argue it is an important first step but it has to be followed by further steps in the coming months. The fact of the matter is that inflation in Europe earlier was going to get more than four times the target. One could argue that a lot of that is being driven by supply chain issues and higher energy prices but there is plenty that is being domestically driven. It is becoming increasingly widespread and started to feed into inflation expectations.

It could feed into wages as well. This is the type of domestic inflationary pressures that the ECB rate hikes can try to counter because they simply cannot control supply issues or the war in Ukraine, ECB has been slower to act but that may have more to do in the coming months but it has been slow to act because domestically, inflation has appeared much more slowly than it has for example in the UK, US, Canada, Australia etc.

So a 50 bps rate hike is an important first step. The inflation rate was higher than markets were expecting. Ultimately it needs to do more though and then at the next meeting, it is going to be critical to lay the groundwork for further rate hikes to come.

This is not going to be enough. More action needs to be taken according to you. The markets fear that such an aggressive rate hike could possibly move the Eurozone closer on the precipice of a recession which means two quarters of economic decline back to back. How will the interest rate hikes impact industrial activity in Europe and do the markets in Europe fear lower GDP and earnings growth?
A recession is highly likely at this point and the European Central Bank has to raise interest rates regardless. One has to ask oneself, what is worse for the Euro area? Is it two consecutive quarters of shallow contraction or is it many years of high inflation? We know how damaging high inflation has been now for the past 12 months and how it is going to happen in the US. I believe that we are going to see recessions over the course of the next 12 to 18 months but shallow ones and as that happens, the central bank will persist with the tightening cycle because they need to get inflation under control. It has to be their priority.

Higher inflation pressures arise from the depreciation of the Euro Exchange Rate. What factors do you think will come into play in the equation that Euro has with the US dollar?
It is something that the European Central Bank can factor that policy around but it is something that ultimately affects inflation. Central banks do not typically care about where the currency is. What they care about is the rate of appreciation or depreciation and what we have seen in the euro in particularly against the US dollar in recent months has been a rapid rate of depreciation and that will have factored into the policy making decision that we saw today because of the inflationary consequences that it could have for the Euro earlier.

So that will have played a role in the 50 bps rate hike today. May be more to come will have an opposing effect. It is hard to say because one of the reasons why the dollar has performed so well in recent months is because the US Central Bank has been raising interest rates so aggressively, as the economy is probably the most resilient that we can see in the western world and therefore the markets believe they can raise rates aggressively and avoid recession.

The Euro area does not really have that benefit and if we see two or three 50 bps being priced into the market in the months ahead, then we could actually see the Euro struggle because that will be seen as tipping the economy into recession, which is a negative for the currency.

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