75bps gain expected but TLTROs and QT on the table

European Central Bank President Christine Lagarde is expected to announce another 75 basis point hike.

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While the European Central Bank is largely expected to announce another rate hike on Thursday, market players are more focused on the other two policy instruments as the region plunges into recession.

The central bank thinks inflation is at record levels, but the economy is slowing, and many economists are predicting a recession before the end of the year. If the ECB takes a very aggressive stance in raising rates to deal with inflation, they risk getting the economy into more trouble.

In this context, it is seen that the ECB raised interest rates by 75 basis points at the end of this week. This will be the second consecutive major hike and the third this year.

“The ECB will likely raise the three policy rates by 75 basis points and suggest that it will go further without providing clear guidance on the size and number of steps to be taken in the next few policy meetings,” said Holger Schmieding, Berenberg chief economist. said in a note on Tuesday.

Given inflationary pressures – the September inflation rate came in at 10% – analysts are pricing in at least another 50 basis points increase in December. The bank’s main interest rate is currently at 0.75%.

“The growing consensus to keep the deposit rate at 2% by the end of the year means a 50 basis point increase in December with a reassessment of the economic and inflation outlook at the beginning of 2023,” said Frederik Ducrozet. Pictet Asset Management’s head of macroeconomic research said in a note Friday.

two big questions

Interest rates aside, there are two questions that need to be answered in the minds of market players: When will the ECB begin to loosen its balance sheet in a process known as quantitative tightening, and what will be the credit conditions of banks in the near future. The ECB undertook quantitative easing for years when it bought assets such as government bonds to simulate demand following the euro crisis in 2011 and the Covid-19 pandemic in 2020.

“When it comes to QT, boring is beautiful,” Ducrozet said, adding that he expects the process to begin in the second quarter of 2023. QT is expected to be “predictable, incremental and passive. It has an Asset Purchase Program (APP), but it’s not actively selling bonds anytime soon,” he said.

Camille De Courcel, head of European rate strategy at BNP Paribas, said in a note Monday that the central bank could wait until its December meeting to elaborate on QT, but it is likely to start reducing its balance sheet by around 28 billion euros. monthly average when it occurs.

But perhaps the biggest uncertainty at this stage is whether credit conditions for European banks will change.

“We’re thinking Thursday [the ECB] TLTRO will announce a decision on its fee or cost. “We think the new measure will only come into effect in December,” he said.

Targeted long-term refinancing operations, or TLTROs, are a tool that provides European banks with attractive borrowing terms – hopefully giving these institutions more incentives to lend to the real economy.

As the ECB is raising interest rates faster than originally anticipated, European lenders are making more money from higher interest rates while taking advantage of attractive loan rates through TLTROs.

“The optics are bad and political pressure cannot be ignored against the backdrop of a historical shock to household incomes,” Ducrozet said. said.

this euro It traded marginally higher at $0.997 against the US dollar on Wednesday. The weakness of the common currency has been a concern for the central bank, although it has repeatedly stated that it does not target the exchange rate.

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