ECB hikes rates, sees big hikes ahead as it announces plan to reduce balance sheet

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

Thierry Monas | Getty Images News | Getty Images

The European Central Bank opted for a smaller rate hike at its Thursday meeting, taking its key rate from 1.5% to 2%, but said it would need to raise rates “significantly” longer to tame inflation. .

They also said that from the beginning of March 2023, it would begin to reduce their balance by 15 billion euros ($15.9 billion) per month on average until the end of the second quarter of 2023.

It said it would announce more details on tapering its asset purchase program (APP) in February, and would regularly reassess the pace of the drawdown to ensure it was in line with its monetary policy strategy. they have

The widely expected 50 basis point rate hike is the central bank’s fourth hike this year. A basis point is equal to 0.01%.

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

“The Governing Council believes that interest rates will still need to rise significantly at a steady pace to reach levels that are sufficiently restrained to ensure a timely return of inflation to the medium-term target of 2%,” the ECB said. in a statement.

‘We don’t shout’

At a press conference following the announcement, ECB President Christine Lagarde said: “Anyone who thinks it’s a pivot for the ECB is wrong. where we have … If you compare it to the Deer, we have more ground to cover. We have further to go.”

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

The central bank said it was working on “significantly revised” euro zone inflation forecasts, which see inflation staying above its 2% target until 2025.

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

However, he sees a “relatively short-term and shallow” decline in the sector.

It comes after the latest inflation data for the euro zone showed a slight slowdown in price rises in November, although the rate remains at 10% annually.

Lagarde told CNBC’s Annette Weisbach, “One of the key messages, in addition to the hike, is the signal that we will not only raise interest rates further, which we had said before, but that we today believes that interest rates must still. greatly increased, in a stable place.”

“It is very clear, based on the data we have now, that a significant increase at a constant pace means that we will have to raise interest rates at a pace of 50 basis points for some time,” she said.

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

Its decision to make an average of 15 billion euro reductions in its APP over four months represents around half of the exemptions over that period, and was based on advice from its market team and its -all central banks and other officials involved in his decisions, Lagarde. said.

“It seemed like an appropriate number to normalize our balance sheet, bearing in mind that the main driver is the interest rate,” she said.

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

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

A Hawkish message

The US Federal Reserve on Wednesday increased its key rate by 0.5 percentage points, as did the Bank of England and the Swiss National Bank on Thursday morning.

“Compared to the Bank of England, this is a hawkish increase, with the forward language [quantitative tightening] and a definitive start date,” said analysts at BMO Capital Markets.

However, they noted that the ECB was reducing other central banks in reducing their balance sheet and that reinvestment would continue under their pandemic emergency purchase program.

“The language in the statement has a functional feel, and the Bank leaves the QT path open,” they wrote in a note.

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

“The main takeaway from this meeting was higher-than-expected inflation projections and thus the need for the ECB to hike more than the market expected,” he said by email.

“Lagarde clearly led the market to expect more hikes of 50 basis points, in February and March, and pushed back against the idea that she would be able to cut rates anytime ‘ soon. final band result, but I think it’s the whole curve that needs to move higher. “

“The QT announcement was more detailed than I would have expected with the size and earlier launch date. This is also contributing to the increase in bond yields, particularly margin bonds, but it is worth remembering that most European bond markets are seeing more net supply. next year after ECB intervention so this is relevant for all countries,” he said by email.

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