ECB to keep hiking as stagflation intensifies

The latest activity indicators show that the economy contracted in October, and the forward-looking measures of new orders and expectations suggest that the downturn will get worse. We have pencilled in a contraction in GDP of 0.5% q/q for the fourth quarter which, aside from during the pandemic, would be the biggest decline since Q1 2009. Nevertheless, inflation accelerated further in October, to 10.7%, and the business surveys suggest that price pressures remain extremely strong. Even if goods inflation eases as global supply-chain problems improve, the continued strength of the labour market should put more upward pressure on wage growth and services inflation. With ECB policymakers seemingly unconvinced that a recession will be enough on its own to bring down inflation, we expect them to continue raising interest rates, taking the deposit rate to a peak of 3%. That would put them in the unprecedented position of hiking during a recession, but it seems almost inevitable.