© Stocksak. FILE PHOTO – Signage seen outside the European Central Bank (ECB), building in Frankfurt, Germany, July 21, 2022. REUTERS/Wolfgang Rattay
Francesco Canepa & Balazs Koranyi
FRANKFURT (Stocksak). The European Central Bank will raise interest rate again on Thursday. They also likely reel in a major subsidy to commercial bankers, taking yet another big step in tightening policy in order to stop an historic surge in inflation.
Fearing that rapid price rises will become entrenched in the economy, the ECB raised rates at the fastest rate ever recorded. It is not likely that this pace will slow down, as it is expected to unwind a decade-worth of stimulus well into next years.
The ECB is very likely to raise its 0.75% deposit rates by 75 basis point – for a cumulative two percentage-point increase in three meetings – and signal that it is still not done.
The bank will likely make the first steps towards reducing its 8.8 trillion-euro balance sheet. This is due to years of debt purchases and extremely low loans to banks.
BNP Paribas (OTC), stated that the ECB was still in catch up mode. “We believe there is now a comfortable majority to take rates into restrictive territory.”
The rate decision will likely be the easiest part of Thursday’s meeting.
Unlike September, no policymaker has publicly opposed the idea for a 75-basis-point increase on Thursday. Markets have fully priced in such an action, suggesting that there is easy consensus, especially considering the U.S. Federal Reserve also hinted at a similar hike.
Christine Lagarde, President of the ECB, is likely to give only vague guidance. She said that while more hikes are necessary, but that incoming data and economic projections for December will be crucial.
Inflation is high and underlying prices growth is increasing, but the overall picture may be more balanced as energy prices are falling. A looming recession will also dampen price pressure and there are no signs that wages are spiraling.
The ECB’s rate decision will be published at 1315 GMT. Lagarde’s news conference will follow at 1345 GMT.
BALANCE SHEET BATTLE
The real battle will be over how to decrease the ECB’s deficit.
The most pressing issue is the 2.1 trillion euro worth of ultra-cheap loans given to commercial banks. These loans are causing both a financial and political headache.
Banks can now park their cash at the ECB, even if they have borrowed at negative or zero rates. This will provide a positive, riskless return that rises with each rate increase.
“The optics are bad against the backdrop of a historical shock to households’ income, and political pressure cannot be ignored,” Pictet economist Frederik Ducrozet said. “Note: Some countries have implemented a windfall income tax on bank profits for the same reasons.”
The ECB would also be justified if it had monetary policy reasons to act. This is because excessive liquidity keeps interest rates too low – money markets rates are still slightly below central bank’s deposit rate.
This effectively stops rate hikes being fully transmitted to the real economic. The ECB will likely decide to modify the terms of the so-called Targeted Longer Term Refinancing Opera, or TLTROs to encourage banks to repay them earlier.
Although the bank will likely change the terms of its bank loan, the devil will be in details as it has limited options.
The most controversial would be an easy change to the terms, which is likely be challenged in court.
“Changing the TLTRO terms could hit the ECB’s credibility and would lead to reluctance of banks to ever make use of the TLTROs in the future again,” ING Economist Carsten Brzeski said.
The ECB might also create a system where borrowing equal to TLTRO reserves would be remunerated at lower interest rates. It could also apply a lower rate to excess reserves.
The topic of how to pay off the 5 trillion euros in debt, mostly government bonds, purchased by the ECB will be a more controversial topic on Thursday.
Although no decision is expected, policymakers will signal that they are planning to end a 3.3 trillion-euro Asset Purchase Programme and not invest all of their cash back into the market.