The ECB is elevating rates of interest and has vital hikes in sight because it pronounces steadiness sheet discount plans

European Central Bank President Christine Lagarde attends a hearing of the European Parliament’s Economic and Monetary Affairs Committee in Brussels, Belgium, 28 November 2022.

Thierry Monasse | News from Getty Images | Getty Images

The European Central Bank opted for a smaller rate hike at Thursday’s meeting, raising its benchmark interest rate to 2% from 1.5%, but said it would need to raise rates “significantly” more to tame inflation.

It also said it would start reducing its balance sheet by an average of €15 billion ($15.9 billion) per month from early March 2023 through the end of Q2 2023.

It said it would provide more details on reducing its asset purchase program (APP) holdings in February and will regularly reassess the pace of the decline to ensure it is consistent with its monetary policy strategy.

The widely expected 50 basis point rate hike is the fourth hike by the central bank this year. One basis point equals 0.01%.

It rose 75 basis points in October and September and 50 basis points in July, taking rates out of negative territory for the first time since 2014.

“The Governing Council is of the view that interest rates still need to rise significantly and steadily to reach levels that are sufficiently restrictive to ensure a timely return of inflation to the 2% medium-term objective,” the ECB said in an explanation.

“We don’t pivot”

At a press conference following the announcement, ECB President Christine Lagarde said: “Anyone who thinks this is a linchpin for the ECB is wrong where we have it. … If you compare to the Fed, we have more to do. We have longer ahead of us.”

“We’re not slowing down. We’re set for the long game.”

The central bank said it was working on euro-zone inflation forecasts, which had been revised “significantly upwards,” and saw inflation above its 2% target through 2025.

It now expects average inflation to be 8.4% in 2022, 6.3% in 2023, 3.4% in 2024 and 2.3% in 2025.

However, it sees a recession in the region as “relatively short-lived and shallow”.

This comes after the latest euro-zone inflation data showed a slight deceleration in inflation in November, although the rate remains at 10% annually.

Lagarde told CNBC’s Annette Weisbach: “One of the most important messages alongside the rate hike is the indication that not only are we going to continue raising rates, which we previously announced, but that we decided today that rates have yet to do so.” rise significantly, in a fixed place.”

“It’s pretty obvious that based on the data we have at the moment, a significant increase at a steady pace means we need to raise interest rates by 50 basis points for a period of time,” she said.

Regarding the quantitative tightening announcement, she said the ECB wants to follow the principles of predictability and measurement.

His decision to cut an average of €15 billion in his APP over four months represents about half of the redemptions over that period and was based on advice from his market team and all central banks and other officials involved in his decision-making, Lagarde said.

“It seemed like a reasonable number to normalize on our balance sheet, considering the most important tool is the interest rate,” she added.

The ECB will achieve the reduction by not reinvesting all of the principal payments from maturing securities into its €5 trillion bond portfolio.

The euro rose from a 0.5% loss against the dollar to a 0.4% gain following the announcement, but European stocks in the Stoxx 600 index fell 2.4%.

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The US Federal Reserve raised interest rates by 0.5 percentage points on Wednesday, as did the Bank of England and the Swiss National Bank on Thursday morning.

“Unlike the Bank of England, this is a restrictive hike given the language [quantitative tightening] and a definitive start date,” said analysts at BMO Capital Markets.

However, they noted that the ECB was lagging behind other central banks in reducing its balance sheet and that reinvestments would continue as part of its pandemic emergency purchase program.

“The language in the statement has an operational feel and the bank is leaving QT’s path open,” they wrote in a note.

Antoine Bouvet, senior rates strategist at ING, also described the announcement as “hawkish”.

“The key takeaway from this meeting was higher-than-expected inflation forecasts and therefore the need for the ECB to rise more than market expectations,” he said via email.

“Lagarde has clearly guided the market to expect further hikes of 50 basis points in February and March, and has resisted the notion that she can cut rates anytime soon. The result is, as you might expect, a surge forward. End of bond yields but I think it’s the whole curve that needs to move up.”

“The QT announcement was more specific than I would have expected given its size and earlier launch date. This also contributes to upside potential in bond yields, particularly for bonds from the periphery, but one should keep in mind that most European bond markets see greater net supply next year after the ECB intervention, so this is relevant for all countries,” said him via email.