The European Central Bank (ECB) is expected to frontload a series of jumbo rate hikes and sacrifice growth in the region due to the increasing cost of living which is threatening to go even higher. ECB's executive board member Isabel Schnabel's speech in Jackson Hole set the tone for the upcoming policy meeting due this Thursday. With inflation in the euro zone expected to surge to at least 10 percent in the coming months and the risk of consumer prices rocketing higher, a "jumbo" rate hike of 75 basis points on Thursday is definitely a possibility. "As frontloaded hikes can have a bigger impact on inflation expectations than a more gradual approach, a 75bp move could make sense," Holger Schmieding, ECB watcher and Berenberg's Chief Economist, said in a research note. "Although it is largely priced in, it could still exacerbate strains in the bond markets." Schmieding added. The recent halt of gas deliveries to Europe through the Nord Stream 1 pipeline has not only pushed stocks lower and raised the risk of a recession in Europe, it has also pushed Italian government 10-year yields to 4 percent — the highest level since mid-June before the ECB unleashed the creation of an anti-fragmentation tool. High yields for Italy — much higher than those in Germany — mean the Italian government has to pay more to borrow, exacerbating concerns over its hefty debt pile. In August, inflation in the euro zone hit 9.7 percent and with the continued pressure on energy prices it is expected to reach double-digit levels in the coming months. At the same time the risk of a recession is looming large over the euro zone economy as consumers feel the pain and scale back their consumption, and companies are struggling with increasing energy prices. "While governments will partially 'foot the bill', there are limits to what extent the private sector can be shielded from this income shock," Dirk Schumacher with Natixis said in a research note to clients. "The drop in consumer confidence to a record low over the last months, indicates that households are aware of these limits with respect to government support. There is also increasing evidence that companies in energy intensive sectors are reducing production." Schumacher added. Because of the inflation outlook, the ECB is expected to sacrifice growth in order to curb inflation, as this is the bank's core mandate. "A key takeaway from recent comments by ECB officials is that the hiking cycle will be less sensitive to recession than we thought," Mark Wall, chief economist at Deutsche Bank in a research note. "We raised our terminal rate forecast by 50bp to 2.5%," Wall added. The ECB's benchmark rate stands currently at zero.
