ECB’s tightening drive isn’t ending after next 75bps hike

Anything but a 75bps hike of the ECB’s key policy rates after next week’s council meeting would be a big surprise. Headline inflation and various underlying price measures reached new highs in September and further increases are likely in the near-term. A repeat of the 75bps hike seen at the September meeting is also fully priced by markets and guided to by various ECB speakers.

What you will learn:

• The bigger question is what comes next. The ECB will probably admit that growth prospects have soured further and that a recession is increasingly likely. But with no signs yet of price pressures peaking, a resilient labour market and more incoming fiscal support, the most dovish signal we can expect is a sign that the pace of rate hikes could slow as we draw closer to neutral rate levels.
• Several council members will also force a debate about quantitative tightening (QT) pushing for a start as early as the start of 2023. An agreement on a framework for this policy shift seems likely later this year given the council remains worried about inflation risks. But even its supporters signal caution, as systemic stress in financial markets is already elevated and growth may disappoint ECB expectations.
• One determinant of the QT decision will be the impact of the likely incoming changes to the ECB’s tender operations (TLTROs) or excess liquidity framework. Several options are on the table, but all will reduce the level of excess liquidity in the financial system. The very large stock of excess liquidity means the impact on market rates may be limited, but it could add to systemic stress.