December ECB Meeting

A group of stuffy old bankers has gathered around a giant mahogany table, sipping on cups of Earl Grey and nibbling on crumpets. They all have furrowed brows and solemn expressions as they discuss the state of the European economy and what actions should be taken next.

Their president Christine Lagarde approaches the mahogany table and explains how bad the Eurozone inflation has become but that their rate hikes are somewhat working; she further explains the latest economic data and proposes a new monetary policy.

Christine Lagarde and the gang have decided to raise European rates with 50 bps, bringing the deposit rate to 2%. Since inflation is still running at around 10% in Europe, this should be just the start of their rate hikes. When the ECB last met, they raised rates with 75 bps; the ECB deciding to take the foot off the gas pedal seems like a terrible idea. The ECB has put itself in a hole, as it cannot sustain higher rate hikes as the eurozone economy is almost in a recession.

Jerome Powel and the gang decided to raise US rates with 50 bps, bringing the total terminal rate to 4.25%. We saw a considerable decline post-decision, even though this was entirely in line with expectations. We saw this massive decline in stocks and crypto because the FED has increased its end-terminal rate. At first, the FED forecasted that interest rates would top out at 4.6%, but because inflation is still above 7%, they decided to increase their forecast to 5.1%. Again, this is a forecast and can change. It is much more likely that this is even higher than 5.1% if inflation does not start going below 6.9%.

Christine Lagarde and her team are seriously questioned on their ability to control inflation. The expectation was that high inflation would pass quickly, especially when it was primarily driven by high and volatile energy prices that policymakers couldn’t control. But economies have faced a series of negative economic spirals that have spurred central banks into action.

The impact of high inflation is starting to bite them back. It’s begun to eat into the regular person's income and the profits of companies and reduce production when factories can’t afford high energy costs.

If inflation continues to climb higher, the ECB should respond with a more assertive monetary policy, but I can never know with those central bankers. The economic outlook is getting worse, leaving households and businesses less able to bear the cost of higher interest rates. Inflation is far above the target rate; I am curious how high these central bankers can push interest rates with worsening conditions. I got to stick around and find out.

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