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75 bps hike expected but TLTRO and QT on the table


Christine Lagarde, President of the European Central Bank, is expected to announce a further hike of 75 basis points.

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With the European Central Bank expected to announce another rate hike on Thursday, market participants seem more focused on two other policy tools as the region heads into a recession.

The central bank sees inflation at record highs but a slowing economy, with many economists predicting a recession before the end of the year. If the ECB takes a very aggressive stance by raising rates to deal with inflation, there is a risk that it will push the economy into further trouble.

Against this backdrop, the ECB is widely seen as raising rates by 75 basis points later this week. It would be the second massive increase in a row and the third increase this year.

“The ECB will likely raise its three policy rates by 75 basis points and suggests it will go further in its upcoming policy meetings without giving clear indications of the size and number of steps ahead,” Holger said. Schmieding, chief economist at Berenberg. , said Tuesday in a note.

Given the inflationary pressures – September’s inflation rate came in at 10% – analysts expect another hike of at least 50 basis points in December. The bank’s key interest rate is currently 0.75%.

“A growing consensus appears to support a 2% deposit rate by year-end, implying a 50 basis point hike in December, with a reassessment of the economic and inflation outlook in early 2023,” he said. said Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management, said in a note Friday.

Two big questions

Aside from rates, there are two questions on the minds of market participants that need to be answered: when will the ECB start to unwind its balance sheet, in a process known as quantitative tightening, and what there lending conditions for banks in the near future. The ECB undertook years of quantitative easing, where it buys assets like government bonds to simulate demand, following the 2011 euro crisis and the Covid-19 outbreak in 2020 .

“When it comes to QT, boring is beautiful,” Ducrozet said, adding that he expects the process to start in the second quarter of 2023. QT should “be predictable, progressive and passive, starting with the end of reinvestments under the asset purchase program (APP) but will not actively sell bonds anytime soon,” he said.

Camille De Courcel, head of European rates strategy at BNP Paribas, said in a note on Monday that the central bank could wait until the December meeting to provide details on QT but that it should start reducing its balance sheet by about 28 billion euros the average per month when this happens.

But perhaps the biggest uncertainty at this point is whether lending terms will change for European banks.

“We believe that Thursday [the ECB] will unveil a decision on the TLTRO, either its remuneration or its cost. We believe that the new measure will not come into effect until December,” said De Courcel.

Targeted Longer-Term Refinancing Operations, or TLTROs, are a tool that provides European banks with attractive borrowing terms, which will hopefully give these institutions more incentive to lend to the real economy.

Since the ECB has raised rates faster than initially expected by the central bank, European lenders are benefiting from the attractive lending rates via TLTROs while making more money from the higher interest rates.

“The optics are poor amid a historic shock to household incomes, and political pressure cannot be ignored,” Ducrozet said.

The euro was trading slightly higher against the US dollar on Wednesday at $0.997. The weakness of the common currency has been a concern for the central bank despite repeatedly stating that it does not target the exchange rate.

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