ING’s Carsten Brzeski argues that the European Central Bank is being guided by its 2022 inflation experience rather than current data, with headline Eurozone inflation still moderate and survey-based expectations easing. Nonetheless, he sees more than a 50% probability of two ECB rate hikes this summer, framed as insurance against falling behind the curve rather than a response to demand-driven inflation.

ECB likely to deliver summer tightening

"Even if the current inflation wave in the eurozone is very different from soaring and self-enforcing inflation in 2022, a lot of the European Central Bank’s actions seem to be driven by the institutional memory of 2022. Not so much by recent inflation developments. So far, the increase in headline inflation has remained moderate."

"Even as some critics argue the ECB risks repeating its 2022 mistake of reacting too late to an obvious inflation shock, the comparison with that period is flawed – not least in terms of fiscal stimulus and savings. Back in 2022, eurozone inflation was already above 4% YoY when the energy price shock hit. The ECB’s infamous late reaction came with the first rate hike in July 2022, when headline inflation was actually above 8% YoY."

"Still, memories of 2022 – and the acknowledgement that the ECB held on too long to the ‘transitory’ inflation narrative – are now driving the push for rate hikes. This is a kind of insurance rate hike, as the risk of doing nothing and potentially falling behind the curve is larger than the risk of any adverse effects on growth from higher interest rates. With our new oil price and inflation forecasts, there is now a probability of more than 50% that the ECB will actually opt for a second hike this summer."

"However, as long as the bond market is doing part of the ECB’s job in tightening financial conditions, governments are not fuelling an inflationary spiral with fiscal stimulus, and sentiment indicators remain weak, it’s hard to imagine that the ECB would really want to fight an exogenous supply shock at the cost of worsening an economic downturn."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)