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75 bps rise expected, but TLTRO and QT on the table

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

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While the European Central Bank is widely expected to announce another interest rate hike on Thursday, market participants are apparently more focused on two other policy tools as the region heads into recession.

The central bank has assessed that inflation is at record high levels, but an economy that is slowing down, with many economists predicting a recession before the end of the year. If the ECB takes a very aggressive stance in raising interest rates to deal with inflation, there is a risk of causing further problems for the economy.

In the middle of this context, the ECB is increasing interest rates by 75 basis points later this week. This will be the second jumbo trip in a row and the third increase this year.

“The ECB is likely to raise its three key interest rates by 75 basis points and suggest it will move forward at its next policy meetings without giving clear guidance on the size and number of steps to come,”[ads1]; Holger Schmieding, chief economist at Berenberg, said in a note on Tuesday.

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

“A growing consensus seems to be in favor of having the deposit rate at 2% by the end of the year, which implies a 50 basis point increase in December, with a reassessment of the economic outlook and the inflation outlook in early 2023,” says 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 answers: When will the ECB start unwinding its balance sheet, in a process known as quantitative easing, and what will happen to lending conditions for banks in the near future. The ECB has carried out years of quantitative easing, in which it buys assets such as government bonds to simulate demand, following the euro crisis in 2011 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 is expected “to be predictable, gradual and passive, starting with the end of reinvestments under the Asset Purchase Program (APP), but not actively sell bonds any time soon,” he said.

Camille De Courcel, head of European fixed income strategy at BNP Paribas, said in a note on Monday that the central bank may wait until its December meeting to provide details on QT, but that it would likely start to reduce its balance sheet by around 28 billion euros a day. average per month when it happens.

75 bps rise expected, but TLTRO and QT on the table

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

“We are thinking Thursday [the ECB] will disclose a decision on the TLTRO, either its remuneration or its cost. We believe the new measure will only come into force in December,” De Courcel said.

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

Because the ECB has raised interest rates faster than the central bank first expected, European lenders are taking advantage of the attractive lending rates via TLTROs, while making more money from the higher interest rates.

“The outlook is poor against the backdrop of a historic shock to household income, and political pressure cannot be ignored,” Ducrozet said.

The euros traded marginally higher against the US dollar on Wednesday at $0.997. The weakness of the single currency has been a concern for the central bank, although it repeatedly states that it is not targeting the exchange rate.

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