The European Central Bank (ECB) raised deposit rates to 0.75% from 0% and signaled further hikes due to its discomfort with energy prices. Of course, most of the rise in energy prices is due to Russia's war with Ukraine and the ensuing sanctions and standoff.
This issue is also likely to push the E.U. into a recession due to its impact on consumption and economic activity as industrial activity becomes unprofitable or limited due to the need to ration energy for households.
The ECB acknowledged that inflation was uncomfortably high and continued to rise. It prioritized the need to tamp down inflation regardless of near-term growth risks. It sees worrisome signs that high inflation is becoming entrenched.
The ECB had lagged behind the Federal Reserve in terms of raising rates. In her press conference, ECB Chair Christine Lagarde suggested that the ECB could continue hiking into the early months of 2023. She was open to whether smaller moves or bigger increases would be necessary at future meetings. She is also currently focused on raising rates to combat inflation rather than running off the balance sheet like other central banks, including the Fed.
Currently, the ECB forecasts inflation peaking just under 10% later this year, continuing a modest rise from its reading of 9.1% in August. The central bank raised its forecast for 2023 inflation to 5.5% from 3.5% and 2024 to 2.3% from 2%. Another factor contributing to inflationary pressures is the weakness in the euro which increases the price of imports, specifically food and energy.
Interestingly, the stock market had a sharp drop, following the ECB decision, giving up early gains on the day. However, markets quickly recovered these losses and finished higher on the day.
In terms of U.S. markets, there's an interesting divergence happening as inflationary pressures continue to ease, while real-time growth measures continue to firm (and perk up in many cases). However, the Fed (like the ECB), continues to focus on inflation and is signaling more rate hikes and a pivot to much lower inflation levels. Yet, it's ultimately responsive to inflation.
So, this is the current dichotomy of the Fed vs the fundamentals. It will be interesting to see which of these the market takes its cues from.