ECB review: 75bp and tightening liquidity conditions

• At today’s meeting, the ECB decided to hike all policy rates by 75bp and gave signals that it is slowing the hiking pace. Lagarde emphasised the data dependency, and the meeting-by-meeting approach to calibrate policy rates. This was in line with expectations and we do not alter our view of a rate hike expectation of 50bp in December.

• There were a number of technical details. These included a small change to the rate by which the minimum reserves are remunerated (now the depo rate and not the MRO rate) and a large overhaul of the TLTRO terms. The latter is set to cause a significant drop in excess liquidity already from 23 November.

• Inflation risks are to the upside, while growth risks are on the downside.

Increasing prominence of slowing growth, but too high inflation leaves ECB narrative broadly unchanged

With the ECB still firmly in tightening mode, the recession risks for the euro area economy are increasing. Inflation remains too high for comfort and the ECB expects it to stay above target for an extended period, as price pressures continue to broaden. Hence, further monetary tightening is needed to guard against the risk of a persistent upward shift in inflation expectations. Lagarde acknowledged that growth in wages may be picking up amid a historically tight labour market, and together with the effect from the depreciating euro this means inflation risk remains firmly on the upside. The ECB’s rapid interest rate increases should further sharpen the downside risks for the economy in 2023, adding to the hit to real disposable income from soaring energy prices. The latest bank lending survey already pointed to deteriorating credit conditions amid waning loan demand, especially for fixed investments. Lagarde also reiterated her call for fiscal policies to be temporary, targeted and tailored to avoid conflicting with the ECB’s inflation tightening mandate.

Reinvestment discussion to take place in December

ECB markets and in particular the periphery were supported by the reinvestment discussion being postponed until the December meeting, where a road map for how to end the full reinvestments is due to be discussed. Whether they come to a formal decision remains to be seen and sources are reported to have suggested that only key principles would be discussed. Markets had implicitly priced in a risk of this road map being presented today, but were relieved by the postponement of the discussion. ECB data show that under the PSPP programme, on which where the discussions will focus, is around EUR20bn/month. Italy outperformed Bunds by 15bp, despite Bund yields declining 15bp on the day.

Changing reserve remuneration

The ECB also announced a change to the reserve remuneration system so banks are no longer remunerated at the MRO rate (2% effective from 2 Nov) but at the deposit rate (1.5% effective from 2 Nov) of their minimum reserve requirement, which is about EUR164bn in total.

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