The European Central Bank decides on rates tomorrow morning.
The interest rate market has fully priced in a quarter point hike for weeks.
A hike in December is also fully priced in. And a hike is priced in for March.
So, that’s 75 basis points of tightening expected over the next six months to respond to a rising headline inflation number. Meanwhile, core inflation in Europe — inflation excluding food and energy — is falling. It’s 2.4%.
A hike tomorrow would be the second quarter point hike since June. That would further destroy demand in an economy that’s barely growing. And of course the inflation isn’t demand-driven anyway, it’s supply-driven — it’s an energy price shock.
As you can see in the chart below, Dutch natural gas traded to €80 per megawatt hour today. That is 2.5x higher than where it sat the day before the strikes. And it’s a new high for this war.
An energy price shock of this proportion is plenty to destroy demand in the eurozone economy. And the ECB is about to pile on.
With that, let’s take a look at two other episodes where the ECB raised rates into an energy shock.
In July of 2008, euro area inflation was running 4%, the fastest in sixteen years, driven by soaring energy prices. Meanwhile, the financial system was wobbling from an unraveling financial crisis. The Fed had cut rates a few months earlier. Oil prices broke $145 a barrel. The ECB hiked rates in response to energy prices and fear of a wage spiral.
Within six months, the ECB had cut by 175 basis points.
They did it again in July of 2011. Greece was already in its first bailout, Trichet raised for the second time that year. Same reasoning. Energy prices and the fear of a wage spiral. The Fed and the Bank of England both stood still.
Within months, the ECB was forced to cut, again.
So, that’s two hiking cycles into energy shocks. Two reversals, both inside a year, and not because the economy was performing well.
The interest rate market isn’t reflecting this history (pricing in two more hikes, after tomorrow), nor is the stock market (benchmark German stocks), which was at record highs just 9 business days ago.
