Economist Warns ECB Rate Hike Would Be 'Big Mistake,' Risking Recession

The European Central Bank would be making "a big mistake" by hiking interest rates in a bid to combat inflation, according to one senior economist, who warns that such a move risks tipping the continent into recession.

Holger Schmieding, chief economist at Berenberg, said Europe's key "big three" economies — Germany, France and Italy — have been weakened by the recent spike in energy costs, leading to a stagflationary environment on the continent.

Butm with new PMI data indicating weakening employment and demand drivers, Schmieding said that demand destruction should "take care" of the inflation part of the stagflation picture, as consumers spend less on other items to cover energy costs — negating the need for aggressive tightening.

"It's important to distinguish between what the central banks unfortunately are likely to do and what would be the right thing," Schmieding told CNBC's "Europe Early Edition" on Friday.

"My impression is that the European Central bank is going to make a big mistake."

The European Central Bank left its main benchmark deposit facility rate unchanged at 2% at its last meeting April 30. But in a statement, its governing council conceded that the upside risks to inflation and the downside risks to growth "have intensified."

The latest annual inflation print for the euro zone area came in at 3% for April, its highest level since September 2023 and well above the central bank's own 2% target.

The ECB is now widely expected to increase rates at its next meeting on June 11. Markets are pricing in an 86% chance of 25 basis points hike next month, BBH said in a note.

"If the European Central Bank hikes rates in June, which it seems hell-bent to do, that would add to the economic misery," Schmieding said. "If the ECB then follows up with further rate hikes, we would probably end up in a mild recession rather than just stagflation."

Laura Cooper, global investment strategist and head of macro credit at Nuveen, said the ECB may embark on so-called "insurance" hikes over the summer, in a move shaped more by inflation projections than spot inflation. But she warned that markets may still be underpricing growth deterioration.

"The greater risk is that policymakers respond to supply-driven inflation persistence by tightening into weakening demand conditions, creating the setup for deeper easing further down the line," Cooper said in a note.