“We don’t see what is coming our way, we are in a comfort zone and foreign demand is very strong, but I think it will be very difficult for the ECB rate hike not to cause a recession.” Guillem López Casasnovas, Professor of Economics at the Universitat Pompeu Fabra in Barcelona, ??does not have too many doubts about where the current economic situation is leading: to a contraction of the economy.
After almost a decade of very strong monetary expansion, a pandemic and a war in Europe that has caused an energy shock, the European Central Bank is preparing to use its weapons to cause a slowdown in the economy that will contain prices. Inflation rose to 8.6% year-on-year in the month of June in the eurozone, the highest rate in its history, with a high risk of becoming chronic if it is not seriously combated.
The factors that have pushed prices up –and anchored inflation expectations– are still there. The ECB’s balance sheet is more swollen than ever, having doubled to almost nine trillion in assets in two years and now stands at more than 82% of GDP. The stimuli are going to stop coming, but no one has withdrawn those that water the economy.
On this monetary base, the mess of the war has been produced, which has triggered energy prices and has contributed decisively to raising all the others. Unfortunately, the Russian aggression continues, and the uncertainty about gas and oil prices is immense. And it will be much greater as winter approaches, if there is no peace.
For this reason, because prices are unbearably high and there are no prospects of moderation in the medium term, the ECB announced a few weeks ago that it would raise rates in July and September to around 0.75% or more to continue along the same path to about 2% next year.
“The markets anticipate more increases than those announced by the ECB, and this will imply that, although there are significant tailwinds in the eurozone economy, there will be a considerable slowdown in consumption and a significant impact on investment,” he predicts. Enric Fernández, chief economist at CaixaBank Research. The eurozone was growing at a year-on-year rate of 5.1% in March, although now, after four long months of war, it is practically at a standstill.
The savings stored after two years of the pandemic will help Spain and other countries to experience an extraordinary summer, as is already being seen with travel, hotel reservations and consumption. But then… then the cold will come.
The example is what is happening on the other side of the Atlantic. In the United States, where the Federal Reserve has already raised rates to 1.75%, the household savings rate has fallen from 7% to 4%, which has helped cushion the blow. But analysts – and markets – also anticipate a recession, which is no longer a taboo word in Fed speeches.
It will probably happen this year and it is expected to be intense and short. This is what is deduced from the movement of the ten-year Treasury bonds in the market. After experiencing an intense rally to bring its yield to the brink of 3.5% in June, the return has now fallen to 2.8%, implying a sequence of rate hikes, recession and rate cuts relatively quickly.
In Europe, with a delay in the cycle and some differences –the shock is much more related to supply than to demand, the labor market is not as stressed and salary pressures are less–, the chances of avoiding recession are slim. The rise in the price of money will move quickly – it is already being anticipated – from Frankfurt to the banks, and will soon begin to produce the desired effect for the central bank.
If inflation remains elevated and the ECB follows the script, the slowdown will be sharp. “Right now we already have meager growth, and we expect inflation to moderate to 4% in the eurozone after the summer,” says Ignacio de la Torre, chief economist at Arcano. “We can avoid recession unless Russia cuts off gas,” he adds. In such a scenario, there would be little to do. Fernández, from CaixaBank, also sees it that way, predicting “a large drop in European GDP” if there is a total supply cut.
And what would happen in not so extreme circumstances? Casasnovas maintains that, even if prices moderate in the coming months –many raw materials are already falling, and some bottlenecks are relaxing–, the adjustment of the economy must be carried out in any case. “Christine Lagarde [president of the ECB] wants the cooling of demand to come more from fiscal policy, and it is clear that Germany will demand that, before mutualizing more debt, each country contributes its own to the process.” The first euro economy has already taken the first steps in this direction, with the announcement of a return to fiscal austerity. It is one more element, along with the rise in interest rates, which paves the way for the slowdown or the dreaded recession.
