La Française AM: Pre ECB Commentary

La Française AM: Pre ECB Commentary

25 oktober 2022

ECB
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By François Rimeu, Senior Strategist, La Française AM

A second consecutive increase of 75 bps leading to neutral territory. ECB balance sheet normalization intentions.

The European Central bank (ECB) is widely expected to raise its three key interest rates by 75 basis points (bps) at its 27 October meeting. 

Please find below what we expect:

  • The ECB to increase its interest rates by 75 bps, bringing the deposit rate to 1.50%.
  • The Governing Council (GC) to reiterate that inflation is far too high and inflation risks remain tilted to the upside. Hence, further rate hikes are coming despite recession risk. Nevertheless, ECB President Christine Lagarde will reiterate the meeting-by-meeting approach to calibrate policy rates.
  • The central bank to announce changes to remuneration on excess liquidity (Targeted long-term financing operations -TLTRO - terms, reverse tiering) to encourage banks to repay TLTRO loans early.
  • Christine Lagarde to indicate the GC’s intention to start quantitative tightening (QT) on asset purchase programme (APP) as the deposit rate moves into neutral territory. We expect the ECB to announce officially its plan for reducing APP bond holdings at the December meeting which should start in the first quarter of 2023. QT will be a gradual and passive process, not involving the active selling of bonds.
  • The ECB to pursue reinvestments under its pandemic emergency purchase programme (PEPP) “until at least the end of 2024” and to apply flexibility to its reinvestments as the first line of defense against euro fragmentation risk.
  • Mrs. Christine Lagarde to reiterate that fiscal policy has to be compatible with monetary policy normalization. 

The ECB will continue to be hawkish in order to maintain credibility and bring inflation back to the 2% medium-term target. Although October Governing Council announcements will not come as a surprise, we believe this meeting may push European Economic and Monetary Union (EMU) sovereign bond yield spreads to widen.

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