The European Central Bank will decide on Thursday whether to continue fighting inflation by raising its benchmark interest rate to a record high or taking a break as the economy deteriorates.

The central bank of the 20 nations that make up the euro has a difficult decision to make. Prices are rising at a rate that is more than twice the Fed’s 2% target even after nine straight rate increases, and they are not anticipated to slow to that level for another two years.

However, rising borrowing prices throughout the globe and China’s economic woes are having a negative impact on economic development, and a recession in the euro zone is now very likely.

Till there were reports on Tuesday that the central bank was set to upgrade its prediction for inflation next year to more than 3%, supporting the case for a hike, analysts and investors had been leaning towards a pause in the ECB’s rate increases.

In order to assess whether inflation, which is still above target at 5%, was moving in the right direction or ran the risk of staying too long at a higher level, policymakers considered the 2024 projection as being critical.

“The inflation momentum is simply too strong for the ECB to pause,” Danske Bank economist Piet Haines Christiansen said.

In a Reuters poll conducted between September 5 and 7, the majority of analysts predicted that the ECB would keep interest rates unchanged this week. However, the money markets now predict an increase, which is anticipated to be the final in a cycle that started in July 2022, with a 63% possibility.

The U.S. Federal Reserve, which started rising rates earlier and has risen higher than the ECB, has been fully priced into the markets as maintaining unchanged rates at its meeting next week.

The rate the ECB pays on bank deposits will rise to 4.0% on Thursday after a 25 basis point hike, marking the highest level since the introduction of the euro in 1999.

When that rate was at a record low of minus 0.5% just 14 months ago, banks had to pay to park their money safely at the central bank.

Thursday was now or never for another increase in borrowing costs, according to UniCredit analysts.

“If the ECB does not hike, it will sound hawkish and will try to convince financial markets that rates could be moved higher at one of its subsequent meetings,” they said in a note.

“We doubt that this will be possible and expect that a decision to hold rates steady today would mark the end of the tightening cycle.”

Inflation, including underlying measures that exclude volatile components, is too high, according to those who favour a hike this week, and the recent spike in energy prices poses a fresh acceleration risk.

However, the rapid tightening cycle, which is twice as sharp as typically anticipated by the ECB’s own banking sector stress tests, has already had an impact on the euro zone economy.

Lending to businesses and families has plunged off a cliff as the industrial sector, which normally requires more cash to operate, is already feeling the effects of higher borrowing costs.

After a brief post-pandemic tourism boom, services have now also begun to struggle.

Germany, the largest economy in the euro zone, is predicted to enter a recession as a result of an industrial downturn.

The ECB is also anticipated to lower its growth forecasts for this year and next on Thursday, which could prompt some economists to argue that it should postpone this month’s rate hike.

“While core inflation is only showing tentative signs of easing, the growth outlook has darkened quickly, implying less need for tightening,” Natixis economist Dirk Schumacher said.

The ECB is poised to start debating how to remove more of the funds it injected into the banking system through various stimulus plans over the past ten years after its rate rises are complete, though no decision was anticipated this week.

(Adapted from FirstPost.com)

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