Published November 18, 2022, 4:13 pm
“We expect to raise rates further and simply withdrawing easing measures may not be enough. The tone was set by Christine Lagarde this Friday. The president of the European Central Bank spoke to an audience of European bankers gathered in Frankfurt. While across the Atlantic, the surprise slowdown in inflation could prompt the Federal Reserve to ease its monetary tightening, the ECB remains determined to go tough.
However, the French acknowledged that the hike in policy rates, of more than 200 basis points since July, was the largest in the central bank’s history. And that a recession in the eurozone was increasingly likely. “Historical experience suggests that a recession is unlikely to reduce inflation significantly, at least in the short term,” repeated Christine Lagarde, before presenting the full arsenal that the ECB is ready to deploy.
In the first place, therefore, the continuation of the crackdowns to reduce demand and curb the rise in prices. “Eventually, we will raise rates to levels that will bring inflation back to our medium-term target,” insisted Christine Lagarde. An orientation supported by Klaas Knot, president of the Dutch central bank. In an apt footballing metaphor, he felt the ECB were alone at halftime. But after two successive 75 basis point hikes, markets are anticipating a slight decline in pace and are forecasting a 50 basis point hike in December.
The second action cited by the president of the Frankfurt institute is the modification of the financing costs of the banks. On 27 October, the central bank decided to tighten the financial conditions of the long-term loans (TLTRO) it had granted to European banking institutions during the crisis. Under certain conditions, they displayed negative rates and banks could earn money by borrowing from the ECB. The goal then was to lower the cost of credit for the real economy.
From now on, the opposite objective is the one pursued by the ECB. He then made these loans more expensive, in order to encourage banks to repay them early. The first refund window opened on Wednesday. But only 293 billion euros – of the 2,100 billion TLTRO outstanding – were brought to the ECB counter. A figure below the estimates of analysts, who instead expected a figure between 400 and 600 billion.
“This could show that banks need more time and that they will be able to use the next few windows to make more significant repayments,” considers Frederik Ducrozet of Pictet, who estimates that the amount repaid could reach 900 billion euros in December. Be that as it may, these approximately 30 billion euros have come to lighten the balance sheet of the ECB which still exceeds 9,000 billion euros. “We can calculate that these repayments will reduce the balance sheet total of the Eurosystem by 3.4% on 23 December. It is therefore an implicit beginning of quantitative strengthening (QT),” points out Eric Dor, director of economic studies at the IESG.
A first step before the real QT, which will see the Central Bank stop gradually reinvesting the sums deriving from the “reduced” redemptions of the securities in the portfolio. “In December we will present the fundamental principles for reducing our bond holdings,” confirmed Christine Lagarde. A delicate exercise, however, which must be carried out with great care.