MNI ECB WATCH: ECB Eye TLTRO Changes As Depo Rate Set For 1.5%

The European Central Bank will likely hike its key deposit rate by 75bps on Thursday, confirming market expectations, and possibly announcing changes in the terms of its cheap loans to banks, as per MNI SOURCES: ECB Seen Changing TLTRO Terms.

Although the hike in the deposit rate to 1.5% and any indication on the forward path will be the main focus of attention, how policymakers look to deal with the growing problem for the national central banks of interest payments on reserve holdings will also be of concern.

Although headline inflation saw some mixed messages in September, slowing in France and Spain, but accelerating in Germany, core inflation picked up again, and policymakers will likely reiterate their belief that a (possibly mild) euro area recession -- of which there is growing evidence and over which there is increasing concern --cannot by itself bring inflation back to the 2% target over the medium term.

NORMALISATION AND QT

Having previously said that rates will need to normalise before the ECB begins the process of unwinding its bond holdings, president Christine Lagarde may indicate that talks on quantitative easing will begin in earnest in Q1 2023, with a view to cautiously rolling off bonds bought under the APP in the second half of next year, probably through a tapered wind-down of reinvestments.

Lagarde is unlikely to be drawn on precisely where both the neutral rate of interest and the terminal rate are. But she will stress that policymakers are watching closely for signs - so far absent - of second-round effects and a de-anchoring of inflation expectations, and repeat the Council’s view that fiscal support measures must remain target and temporary if they are to avoid further fuelling inflation.

Against this backdrop, the Governing Council will indicate its preference for continuing to make policy on a meeting-by-meeting basis, albeit with a hike of at least 50bps penciled in for December -- when the latest Eurosystem staff macroeconomic projections will be available -- with a possible signaling of a willingness to move in smaller increments thereafter.

With no new projections expected from the ECB staff until the December meeting, the narrative of higher prices and slowing growth will remain in place. But inflation hovering around double digits and growth set to slow further in coming months, the resolve of policymakers to deliver on further hikes to meet market prices could yet be tested in the meetings ahead.