Fighting Inflation Could Worsen Countries' Credit Ratings | Daily Market Analysis

Key events:

Eurozone - ECB's Lane Speaks

ECB minutes came out. From the minutes of the September meeting of the ECB, it follows that the members of the regulator fear the consolidation of inflation at an elevated level. That's why the rate was raised by 75 basis points, not 50, as the markets expected. For the return of price stability, politicians are willing to sacrifice economic growth in the eurozone.

However, the question is still here — what about a possible debt crisis? Wouldn't the ECB follow the Bank of England`s lead?

The problem is that a mere decline in consumer activity is not enough to get CPI back to the 2% target. Recall that inflation in the bloc reached 10% at the end of last month. On the other hand, the regulator does not have many tools. Having put a stop to the quantitative easing (QE) policy, the debt market will face increased volatility.

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To avoid a repetition of the 2010 crisis, the ECB is likely to limit itself to rate hikes. In case of an urgent need, it might be followed by recommendations for tight fiscal policy. The euro does not react to these risks so far, trading already below 0.98 against the dollar. By the way, the depreciation of the euro adds inflationary pressure in the Eurozone.

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The regulator has no choice but to continue the cycle of a key rate increase. It is not the best news for the EU economy and we should expect deterioration in some sectors.

The cherry on the cake might be a downgrade of the credit ratings as it happened in the case of the United Kingdom. As you know, Fitch analysts downgraded the outlook on the long-term rating of the UK from "stable" to "negative". The reason for this was the government's plans to reduce taxes, which will lead to an increase in government debt. According to preliminary estimates, the state budget deficit in 2022 will be 7.8% of GDP, and in 2023 - 8.8%. These are quite frightening figures.

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What is the danger of lowering the credit rating? First of all, an increase in the cost of borrowing. The higher the risks, the higher the yield. Thus, the cost of raising additional funds will cost the government a pretty penny. Whereas in the case of Britain there are no problems with finding investors, the situation with Spain, Greece, and Italy is somewhat different.

Moreover, we need to be clear. Very soon the rating agencies will start their activities to "cut" the ratings of the countries. We have to be prepared for this. And this process can very unpleasant for the markets.