The Fed is Set to Hike Rates and then the ECB…

As Americans step up their rate hikes to address concerns about inflation, the other side of the Atlantic Ocean is about to do the same.

The ECB President Lagarde has recently said that there have been some radical changes in both the economic and geopolitical landscape, making clear her intentions.

The reason for this statement was probably to remove the rhetoric of “It’s too early for a rate hike” that began a year ago. Lagarde announced at the June meeting that the ECB had decided to take further steps in “normalising” its monetary policy. This could mean two things:

  • The measures we’ve taken so far were for desperate times, now we are going back to normal.
  • Our current policy is not suitable for the economic conditions we are living in. So, we will do whatever is necessary.

It’s interesting that Central Bank Presidents always use such soft words to announce radical changes. But apparently, they take into account the mood of the patient before starting to treat them. By saying that the problems in the manufacturing industry continue in terms of high production costs, Lagarde meant that the service industry support Europe’s economic growth. Of course, it is not possible to maintain development in Europe with this industry alone. Growth prospects have already become more modest due to high energy costs, deterioration in trade, increasing uncertainty and high inflation. Lagarde said that the economy in the Euro Area is expected to grow by 2.8% this year, and by 2.1% in 2023 and 2024.

The inflation rate in the Euro Area was 8.1% in May, mostly due to energy prices, which increased by 39.2% in one year.

“Inflation Can Get Sticky…”

Wage increases in Europe continue as a social obligation. I think, putting the social side of the matter aside, Lagarde pointed out that wage increases negatively affect the long-term inflation expectations.

The ECB President projects that inflation will finish the year at 6.8%, dropping to 3.5% in 2023 and 2.1% in 2024. Lagarde also said that the ECB will make some serious decisions on the asset purchase programme and interest rates in July, and increase rates by 25 basis points, adding that “If it is not enough, we will hike rates further in September”.

It looks like an interest rate hike will come first in July and then another one in September. However, if inflation concerns do not subside in the July-September period, higher interest rates will be inevitably introduced.

As a result of these statements, the parity climbed above 1.05. However, I think that the parity will be stabilised following the next steps from the Fed. I can say that the parity will fluctuate in a narrow range with the interest rate decisions from both sides of the Atlantic.