What will the ECB decide in September’s policy meeting

The European Central Bank will hold its September policy meeting on Thursday, with a million dollar question what the policymakers will decide in the situation when the central bank is pressured by two strong and opposite forces.

The phase of record-paced interest rate increases during past one year, when the ECB lifted its deposit rate from negative territory to the current 3.75%, should logically come to its end, as inflation eased significantly from its record high at 10.6%, hit last October, impacted by sharp monetary policy tightening.

On the other hand, strong rise in borrowing cost started to hurt economic growth with the full-scale impact on the Eurozone’s economic activity is still to be seen, threatening of further slowdown of already fragile economy, which could lead into chaotic scenarios.

The EU bloc’s economy has been exhausted by various negative factors, primarily as a result of the reverse impact of strong sanctions that the EU imposed on Russia, which caused the domino-effect.

Soaring inflation was the first shock, with wrong estimation of policymakers, which initially adopted American view of ‘transitory inflation’ and delayed the action, leaving more space for inflation to accelerate, before eventually making decision to start tightening the monetary policy.

Sharp rise in interest rates managed to push inflation into downward trajectory and reduce price pressures, but the major threat comes from sticky prices, which may significantly delay and complicate the whole process of bringing inflation back to 2% target.

What will be ECB’s priority: elevated inflation or slowdown in economic growth?

Inflation in the Eurozone is still around 2 ½ times above the target, with so called core inflation, which excludes the most volatile components and closely watched by the central bank as a gauge of inflation, being stuck above 5% and warning of prolonged phase of increased inflationary pressure.

This will be strong warning for the central bank to remain ready for further tightening, with still high bets for another 25 basis points hike, though clock for the ECB is ticking and September meeting would be probably the last chance to do so, as economic data are likely to worsen, which will further complicate the central bank’s job in coming months.

The ECB policymakers are divided in a way, with doves pointing to cautious approach and favor decision to stay on hold, while hawks advocate for more aggressive approach, but so far do not explicitly support scenario of another hike in September, adding to expectations that the ECB will pause this time.

ECB President Lagarde continued repeat her old mantra that the ECB will continue to closely watch the conditions and act in appropriate way and timely manner, with decisions to be data dependent.

This sounds slightly contradictory, as results of the latest campaign are still not visible, but conditions continue to deteriorate, with no clear signs when the crisis will start to ease, signaling that the ECB is standing at the crossroad where each road leads to dead end.