Are the ECB rate hikes over?
ECB: Most of the rate hike now behind us, the focus shifts to budget reduction. The analysis by Martin Wolburg, Senior Economist of Generali Investments
In yesterday's meeting, the ECB raised key interest rates by another 75 bps, thus bringing the deposit rate to 1.5% and the repo rate to 2.0%, in line with expectations. On the TLTRO III, it decided to offer additional early repayment dates and to link the applicable interest rate from November 23 onwards to the applicable average key rates in order to "strengthen the transmission of policy rate increases to bank loan conditions" . It also decided to set the remuneration of minimum reserves at the rate on deposits with the ECB rather than the higher rate on the main refinancing operations (MRO) so far. The prospective indications on reinvestments made under the APP (“for an extended period” after the first rate hike) and the Pandemic Emergency Purchase Program “at least at the end of 2024” were maintained.
Inflation remains the guest of stone: at 9.9% yoy in September, inflation hit a record high. Looking ahead, the ECB expects large-scale inflationary pressures. In the question and answer session, President Lagarde acknowledged that for 2023 the latest growth projection of the ECB (equal to 0.9%) seems too optimistic, but that not even the most negative scenario (-0.9%) was not applicable. He also acknowledged that the risk of a recession has intensified.
Overall, it has become very clear that the ECB's Governing Council remains on a tight trajectory. But with the deposit rate now in the middle of a corridor considered neutral, the magnitude and speed of future rate hikes are less certain. In the Q&A, President Lagarde mentioned inflation prospects as factors determining future political action – in a context of a greater likelihood of recession, the measures adopted so far – 200 bps up in the last 3 meetings – and the transmission of the past monetary policy action. He also strongly emphasized the approach of evaluating meeting-by-meeting and data dependence. With the Council acknowledging that it had made "substantial progress in withdrawing the monetary policy adjustment", it "expects to raise interest rates further" but no longer "in the next few meetings" as indicated in September.
Instead, it has become clear that the ECB will step up measures to reduce its balance sheet. The changes announced in the TLTRO III conditions, with three additional early redemption dates, will allow for a faster balance sheet shrinkage and help convey the restrictive political conditions to the real economy. A positive side effect Lagarde explicitly mentioned is that it will be cheaper for banks to repay loans earlier as more collateral will be available. Additionally, while no changes were made to APP reinvestments yesterday, Lagarde announced that key principles on QT will be announced at the December 15 meeting.
Overall, the ECB meeting confirms in our view that most of the increase (already cumulative 200 basis points currently) is behind us. As we expect, contrary to the ECB's current projection, a recession in the euro area, we see room for maneuver for the ECB to reduce the magnitude of further rate hikes in this perspective as well. Another 50bps rate hike in December and another 50bps in the first quarter of 2023 still looks very likely to us and we continue to see the benchmark rate peak at 2.5%. The market response to the meeting was very accommodating with falling yields and euro, and a tightening of euro area non-core bond spreads. In fact, immediately after the meeting, the market discounted some rate hikes (with the implicit policy rate no longer above 2.5%). But we doubt he still priced in the imminent effect of quantitative tightening due to a lack of information. Overall, the risks to the ECB rate outlook now appear more balanced.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/sono-finiti-i-rialzi-bce-dei-tassi/ on Sun, 30 Oct 2022 06:05:26 +0000.