© Stocksak. FILE PHOTO – European Union flags fly in front of the European Central Bank headquarters in Frankfurt (Germany), April 26, 2018. REUTERS/Kai Pfaffenbach/File Photo
By Dhara Ranasinghe, Stefano Rebaudo and Kripa Jayaram
LONDON (Stocksak), Thursday – The European Central Bank met on Thursday. It appears that it is not in a mood to slow down the pace of aggressive interest rates hikes given red-hot inflation — even though the economic outlook is dimming.
It has increased rates by 125 basis points (bps), the fastest pace of policy tightening ever recorded.
Although recession risks are unlikely to impede the path for now, markets are looking for signs that a pause might be coming.
“The central bank has few choices but to give another huge rate increase and sound hawkish,” stated Jan von Gerich, Nordea Chief Analyst.
Here are five key questions for the markets radar.
1/ What will ECB do this Week?
Stocksak polled economists to predict a 75 bps rate rise to 1.5%. Market pricing supports this view. Many policymakers favor a substantial rate hike. However, most prefer 75 bps.
The ECB may announce a possible change in the rules governing short-term loans that are low-cost, Targeted Longer Term Refinancing Ops (TLTRO).
Investors will also be looking to Christine Lagarde (ECB boss) for guidance about how the ECB views inflation and recession risks, and when it might pause tightening.
“It is reasonable to expect a 75 bps increase in rate, signals about ECB reducing balance sheet and changing rules about TLTRO to decrease excessive liquidity,” he stated. Deutsche Bank (ETR:),’s Global Head for Rates Research Francis Yared. “What isn’t clear is how much all this will be announced (this week).
(ECB set for another supersized rate hike https://graphics.reuters.com/GLOBAL-MARKETS/myvmomnnovr/chart.png)
2/ Are there any signs that inflation is at its peak?
Economists believe it’s too soon to predict a peak in inflation, but there are increasing chances that one will arrive soon. Inflation has accelerated up to almost 10%, a level that has not been seen in some countries of the Euro zone in over 70 years.
One reason to be optimistic about European gas prices is that they are now down 65% from August’s peak.
Bostjan Vasle, ECB policymaker, believes that an inflation peak is possible if there aren’t any additional shocks from the conflict in Ukraine. However, the retreat will be slow at first.
Another problem is that inflation can be broad. This means that even though headline figures may fall, underlying price increases will still be uncomfortably high.
The inflation peak is critical to determine whether policymakers will need rate increases beyond the neutral setting, where they neither stimulate nor slow down growth. This is generally a rate between 1.5% and 2.5% but some policymakers believe it is too low.
(Is Euro zone inflation peaking? https://graphics.reuters.com/EUROZONE-MARKETS/dwpkdgrwmvm/chart.png)
3/ Are We About to Get QT?
Not yet. However, the ECB may change its language on reinvestments in the future and provide more information.
Next up is the issue of how to reduce the ECB’s 5 trillion euro debts. This is called quantitative tightening (QT).
Joachim Nagel, president of Bundesbank, and Klaas Knot chief of Dutch central banks, both stated that QT, a part in broader policy tightening is coming soon.
(The easy-money era is over The easy-money era is over https://graphics.reuters.com/GLOBAL-MARKETS/byprjzaaxpe/chart.png)
4/ Is the ECB giving cash to banks? And what will it do?
Banks in the Euro zone have 2.1 trillion euros worth of cash, which was given by the ECB at extremely low, sometimes even negative, rates to stimulate the economy.
Banks can store this cash at the ECB in large rate increases, earning a profit that is risk-free. This frustrates policymakers who see it as gaming the system.
According to some, policymakers are close to a deal to amend rules governing bank loans. This would allow banks to make tens of trillions of euros more profit. A decision could be made on Thursday.
(Who wins the ECB cash giveaway? Who is eligible to win the ECB’s cash prize? https://graphics.reuters.com/EUROZONE-MARKETS/gdpzqryowvw/chart.png)
5/ How worried should the ECB be about financial instability?
Concern about financial instability has been raised by aggressive rate hikes from the major central banks as well as a decline in British bonds.
According to the International Monetary Fund financial stability risks have increased substantially. Lagarde has warned markets that they may be too optimistic about economic prospects, raising the possibility of an abrupt market correction.
FlavioCarpenzano, Capital Group’s fixed income investment director, stated that financial stability is the key issue for markets. However he doesn’t expect the ECB will address it directly.
(Worries about financial stability risks are growing Worries about financial stability risks are growing https://graphics.reuters.com/GLOBAL-MARKETS/zjpqjqkrzvx/chart.png)