ECB rate setters worried that weak euro would fuel higher inflation

European Central Bank rate setters expressed growing concern that the weak euro would fuel higher inflation when they decided last month to raise interest rates for the first time in more than a decade, the minutes of their meeting released Thursday show.

During the deliberations of the ECB Governing Council in July, concerns about rising inflation, which some feared could not be contained even if the energy supply crisis were to deepen, seemed to outweigh concerns about weakening growth prospects.

Policymakers at the meeting raised the ECB’s deposit rate by a more-than-expected half a percentage point to zero and indicated more hikes were to come.

“Members widely noted that the depreciation of the euro represented a significant change in the external environment and implied greater inflationary pressures for the euro area, in particular due to higher costs of energy imports billed in US dollars,” the statement said. ECB.

Some policymakers argued that it should stick to its earlier plan for a 25 basis point rate hike in July, rather than the 50 basis point hike it ultimately decided on.

But most of them voted in favor of their decision to launch a new bond-buying program to address unwarranted differences in borrowing costs between eurozone member states – also known as the transmission protection instrument – and allowed them to bolder approach.

Rate setters identified a growing number of upside risks to inflation, which hit a record high for the eurozone of 8.9 percent in July. In addition to the weaker euro, these included “a sustained deterioration in the productive capacity of the euro area economy, continued high energy and food prices, inflation expectations above [the 2 per cent] target and higher than expected wage increases”.

“It has been argued that even a recession would not necessarily reduce upside risks, especially if it was related to a gas freeze or other supply shock implying a further rise in inflation,” the ECB said. However, other councilors argued that low growth “would itself drive low inflation”.

Since last month’s meeting, economists have raised their forecasts for inflation in the eurozone for the next two years, as European wholesale gas and electricity prices rise to record levels in response to fears of a possible deficit due to further austerity measures by Russia.

This has led investors to bet that the ECB will raise interest rates by another half a percentage point at next month’s meeting in a bid to cool price growth, although many economists fear the eurozone could slip into recession this winter. .

The aggressive mood is likely to be echoed in this week’s meeting of central bankers in Jackson Hole, Wyoming. Federal Reserve Chairman Jay Powell is expected to underline the central bank’s commitment on Friday to do whatever it takes to fight inflation, even if she determines it may soon be appropriate to make smaller rate hikes than the third consecutive 0.75 percentage point increase that some Fed rate-setters have called for next month.

Aggressive rate hikes in the US are one of the factors behind the euro’s decline against the dollar, along with the deteriorating outlook for the euro-zone economy and the dollar’s traditional role as a haven during recessions.

Against the dollar, the euro traded at $0.9966 on Thursday, just slightly above the 20-year low it reached last week.

“It was argued that if the current risks of recession in the US economy materialized, the euro would be expected to rise,” the ECB said in its report from last month’s meeting. “However, an offsetting – and likely dominant – effect could be due to a deterioration in global risk sentiment, typically implying a strengthening of the US dollar.”

Policymakers said the eurozone economy had “shown demonstrable strength and resilience in the face of multiple crises”. This was underlined on Thursday when Germany revised its estimate of gross domestic product for the second quarter from its initial estimate of stagnation to 0.1 percent growth. Separate survey data also showed that sentiment for German companies and French manufacturers continued to decline, but less than expected.

Are we heading for a global recession? Our economics editor Chris Giles and US economics editor Colby Smith discussed this and how different countries are likely to respond in our latest IG Live. look at it here.