75 basis points higher expected but TLTROs and QTs on the table

while the European Central Bank Another rate hike is largely expected on Thursday, and market players appear to be focusing more on two other policy tools as the region approaches recession.

The central bank was thinking Inflation has reached record levels But the economy is slowing, with many economists predicting a recession before the end of the year. If the ECB takes a very tough stance in raising rates to deal with inflation, there are risks that it will cause more problems for the economy.

Amid this context, the European Central Bank is widely expected to raise interest rates by 75 basis points later this week. This will be the second huge increase in a row and the third this year.

“The European Central Bank is likely to raise its three policy rates by 75 basis points and suggest it will go further in the next few policy meetings without providing clear guidance on the size and number of steps ahead,” Holger Schmieding, chief economist at Berenberg. , he said in a Tuesday note.

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

“There appears to be a growing consensus in favor of a deposit rate of 2% by the end of the year, implying a 50 basis point increase in December, with a reassessment of the economic outlook and inflation in early 2023,” Frederic Ducruzette, head of macroeconomic research said. At Pictet Wealth Management, in a note on Friday.

Regardless of rates, there are two questions on the minds of market players that need to be answered: when will the European Central Bank begin to unravel its balance sheet, in a process known as quantitative tightening, and what will happen to banks’ lending terms in the near future. The European Central Bank has undertaken years of quantitative easing, buying assets such as government bonds to simulate demand, in the wake of the euro crisis in 2011 and the COVID-19 outbreak in 2020.

“When it comes to QT, boredom is beautiful,” Ducruzette said, adding that he expects the process to begin in the second quarter of 2023. QT is expected to be “expected, gradual, and passive, starting at the end of reinvestments under the asset purchase program.” (APP) but not actively selling bonds anytime soon.”

Camille de Courcel, head of European price strategy at BNP Paribas, said in a note on Monday that the central bank may wait until the December meeting to provide details on QT, but it is likely to start reducing its balance sheet by about €28 billion a day. Monthly average when this happens.

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

We think Thursday [the ECB] He will unveil a decision on TLTRO, either its reward or its cost. We believe the new measure will only come into effect in December.”

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

Since the European Central Bank has been raising interest rates faster than the central bank initially expected, European lenders are taking advantage of attractive loan rates via TLTROs while making more money from higher interest rates.

“The optics are poor against the backdrop of a historical shock to household incomes and political pressure cannot be ignored,” Ducruzette said.

The euro It traded slightly higher against the US dollar on Wednesday at $0.997. The weakness of the single currency has been a concern of the central bank even though it has repeatedly stated that it is not targeting the exchange rate.