Frederik Ducrozet, Head of Macroeconomic Research chez Pictet Wealth Management.

The deepening of the energy crisis has been the catalyst for a fresh round of government support measures, including discussions about various price cap mechanisms at the European or national level, changes to regulation of energy markets, direct support for households and companies, tax cuts, credit line and state guarantees for stressed energy providers and SMEs.

In the euro area, the total amount of fiscal spending that has been announced so far this year is exceeding 2% of GDP, although the final impact on activity and inflation remains uncertain because of timing and implementation issues. Meanwhile, gas and electricity prices are on the rise again after Russia shut off Nordstream flows completely on Friday.

In Germany, the government announced a (third) fiscal package over the weekend worth €65bn (1.8% of GDP), including a wide range of measures to support households and companies as well as a plan to cap electricity prices using “excess profits” of power generators as a source of revenue. Details are scarce and the cap may only be implemented if nothing is decided at the EU level. Direct support measures will help mitigate the income shock via one-off payments to low-income households, social contributions and tax cuts, and other targeted subsidies (see table below). Including the latest package, Germany now stands out as one of the most fiscally active member state, although fresh initiatives are to be expected in other countries in coming weeks.

For all the uncertainty, our inclination is to believe that the latest fiscal measures will reduce downside risks to growth, but not offset them completely. Moreover, most measures may only reduce inflation marginally (by less than 1% in most cases) for a limited period of time. Net net, we see little reason to change our GDP forecasts (see our Flash Note “Euro area: a policy-mix dictated by energy worries”, 29 August).

Still, central banks should welcome any initiative that help reduce the burden on the most vulnerable households and energy-intensive companies. Assuming a near-term boost to growth but a more modest impact on inflation, fresh fiscal support should be consistent with a tighter monetary stance, or at least political cover for central banks to keep hiking rates.

The ECB’s Governing Council will meet on Wednesday and Thursday, ahead of an important EU Council on Friday discussing policy options to stabilise the gas market. Following an hawkish offensive at Jackson Hole and the upside surprise in euro area core inflation in August, the ECB is likely to speed up the pace of tightening by delivering a 75bp rate hike. We highlighted the risk of a 75bp hike in June following the ECB’s conference in Sintra, but that was on the basis of a 25bp hike in July, which was essentially carved in stoneuntil the very last minute. Now that expectations have been more carefully recalibrated and the rationale for a 75bp hike was laid out (see recap below), the ECB is unlikely to surprise on the dovish side especially as the currency remains under pressure, adding to the imported inflation problem. ECB Chief economist Philip Lane is unlikely to veto a 75bp hike, although he may try and water down any guidance of a series of larger rate hikes.

Regardless of the sequencing, the ECB’s main goal will be to front-load monetary tightening, whatever it breaks, until policy rates reach a more ‘neutral’ level, between 1% and 2%.

We continue to believe that the ECB will pause its hiking cycle in a recession that looks more severe by the day, even if policy normalisation could resume later in 2023. For now, risks are tilted towards a faster front-loading and a higher terminal rate as fiscal policy steps in.

Note that the ECB has other tools than policy rates to normalise its stance, including Quantitative Tightening of the Asset Purchase Programme, changes in TLTRO parameters (if not ending them altogether), or the remuneration of excess reserves, which are all likely to be discussed in coming months.