3 reasons why the ECB will hike by 50bp at its July meeting

The first three days of the trading week are marked by the ECB Conference in Sintra, Portugal. Following the Federal Reserve model of the  Jackson Hole Symposium, the ECB has organized its own conference to be held yearly.

During the pandemic, the conference was held virtually, but now it is back on track. Central bankers from all over the world as well as financial press representatives and ECB watchers, attend the conference.

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Later today, a panel consisting of the Fed Chairman, the ECB President, and the Bank of England’s Governor will definitely move financial markets.

For traders, everything said during this conference might be a market mover. That is especially true for the euro pairs as the ECB prepares to hike the interest rates from their lowest level ever.

The ECB chose not to hike the rates in June, despite other central banks doing it so already. Even the Swiss National Bank, known for its easy stance, hiked by 50bp.

But inflation keeps rising in Europe. Earlier today, Spanish inflation rose to 10.2% YoY, much higher than the 8.8% expected.

It has reached double-digit territory, and many European citizens believe that the ECB has lost touch with reality. However, to its credit, the ECB had a hard time raising the rates due to the conflict in Ukraine. The danger of hiking too early was to send the European economies straight into a recession.

So here is why the ECB will hike by 50bp in July:

• Core inflation is on the rise
• The window for hiking rates closes shortly

Core inflation keeps rising

Two things surprised today in the Spanish inflation data. One is the fact that it reached the double-digit territory.

Another is that the rise in energy prices accounted only for about 5.5% of the inflation rate. The rest belonged to core inflation, which is much higher than the ECB’s definition of price stability.

The window for hiking rates closes shortly

A central bank cannot just raise the interest rates if it is not appropriate. During economic growth, it is the opportune time to do so.

By lifting the rates, the central bank prepares for the time when it needs to cut the rates again to fight the next recession. The business cycle theory tells us that an economy grows through periods of booms and busts, expansion and contraction, and the interest rates are the appropriate tool to use.

The ECB appears to be behind the curve. The Fed already has the rate at 1.75%, with similar inflation. As such, it can cut smoothly when the next recession comes.

And the next recession is feared to be closer than many expect. Therefore, if the ECB does not hike by 50bp in July, it will miss its opportunity as a recession might come towards the end of the year or early 2023.