MNI STATE OF PLAY: ECB Ponders Size Of Hike As Gas Supply Cut

The European Central Bank will opt between a rate increase of 50 or 75 basis points at its meeting on Thursday as its staff macroeconomic projections are expected to show that growth is stalling in a continent facing possible energy shortages while inflation is set to remain above target for an extended period.

While policymakers are keen to take rates towards neutral levels somewhere between 1% and 1.5% by the end of the year as prices surge and the euro weakens, the size of the increments with which to achieve this is under debate. Eurozone inflation hit 9.1% in August, with core inflation above 4%, but the economy may also be heading into a recession starting in the fourth quarter. (See MNI SOURCES: Both 75, 50BP Still In Play As ECB Readies Hike)

Russia has now turned off gas supplies to Europe, potentially both further fueling price increases while undermining output, and a weak euro and aggressive tightening by the Federal Reserve are also complicating the ECB’s calculations.

"FORCEFUL"

Some Governing Council members seem more willing than others to hike into a shallow recession, but the ECB is likely to use strong language to indicate its determination to fight price increases after weeks during which hawkish national central bank governors have insisted on the need for “forceful” interest rate action, while more cautious counterparts rallied behind calls for “prudence” and steady “determination.”

President Christine Lagarde will continue to make the case for a gradualist approach to rate hikes, allowing the Governing Council to calibrate policy meeting by meeting, while emphasising the need for targeted fiscal support for businesses and households most affected by the energy crisis.

Remuneration of banks’ excess liquidity held at the ECB may also be under the spotlight, after Dutch central bank boss Klass Knot last week indicated that committees tasked in July with investigating the options open to policymakers will report back in September or October.

The ECB’s balance sheet is set to come under renewed focus and could form a “key feature” of the normalisation process, Knot said - though he did not expect discussions around winding down APP reinvestments to begin in earnest until later in the year.