The European Central Bank will hold its policy meeting today (Thursday, September 8th) and markets are expecting a rate hike, for sure.
The question now is: will it be a 50-basis points (bps) hike? Or 75bps?
Keep in mind that either of those two options listed above are still larger than the customary 25bps rate adjustments that major central banks typically trigger per policy meeting (at least in pre-pandemic times).
Why are central banks hiking rates?
Rate hikes are intended to “destroy” some of the demand levels in an economy, in order to rein in inflationary pressures.
The intended effect is the same: sucking out more money from the economy.
Hence, when there’s less money chasing after goods and services, the businesses that supply such goods and services would be less emboldened to keep raising their selling prices = slower inflation.
What’s supporting the argument for a 75bps hike?
In short, record-high inflation.
In August, the Eurozone’s consumer price index rose by 9.1% compared to August 2021.
As such, markets are now pricing in a 68% chance that the ECB will proceed with a 75bps hike today.
Yesterday’s release of the 2Q GDP’s final print showed an upward revision of 0.2 percentage points respectively for quarter-on-quarter growth (0.8%) as well as the year-on-year print (4.1%).
In other words, those better-than-expected GDP figures imply a healthier-than-expected economy last quarter that’s better able to withstand higher interest rates.
Why consider a “relatively smaller” 50bps hike?
Rate hikes are not fool proof. Interest rates that are raised to high too fast could have damaging consequences for the economy.
A business that’s struggling with higher loan repayments may then have to curb hiring, or even lay off workers, so as to stay solvent. Job losses may then mount. When folks lose their incomes, they have less capability to spend. This may in turn translate into lowered incomes for businesses, given that their customers are now spending less.
If too much demand is “destroyed” in one go, it could ultimately lead to a recession.
That’s the conundrum facing ECB officials today: how high do they raise interest rates without doing too much damage to the Eurozone economy.
And that’s a tricky task, considering all the economic woes that the Eurozone is currently facing, including an energy crisis stemming from the still-raging war off to its Eastern borders.
How are rate hikes impacting stock markets?
Generally, stocks are considered to be a higher risk investment.
And when interest rates go up, raising borrowing costs while also eroding demand along the way, it sours the market’s appetite for taking on more risk.
Already, recent history has shown that the financial market tends to anticipate such decisions before they actually occur.
Hence, the 18.5% year-to-date drop for the Euro Stoxx 50, which is an index comprising fifty industry-leading companies in the Eurozone.
How might the STOX50 react to the ECB’s decision today?
Ultimately, the immediate upside for the STOX50 remains capped by the swirling concerns surrounding the souring Eurozone economic outlook.