The European Central Bank (ECB) chooses to slow down the rate hike path, increasing the cost of money by 50 basis points. After the increase from half a point in July, and from 75 basis points in September and October, Christine Lagarde is starting to see the fruits. The inflation data in November, down on an annual basis, was decisive. The novelty, as expected, is the announcement of the reduction of the balance sheet, the so-called “Quantitative tightening”, or Qt. It will start in the second quarter of 2023. For the next increases, keep an eye on February. The normalization of monetary policy in the euro area is not over yet.
He had said it several times, and so it was. The ECB has decided to reduce the pace of interest rate increases. A not so obvious decision, since the northern front (Germany, the Netherlands, the Baltics, Austria, Belgium, Slovenia and Slovakia) were asking for an increase of three quarters of a point, the third in a row. The collegiality that Lagarde always asks for once he enters the Governing Council has won. This results in the increase from 50 points today and further increases in the future. ‘The Governing Council considers that interest rates still need to increase significantly at a steady pace to reach levels restrictive enough to ensure a timely return of inflation to the 2% target over the medium term.’ We will proceed with the usual gradualness, explains the ECB, with decisions taken meeting by meeting, based on the data available. Which, according to the latest macroeconomic estimates presented today, are mixed, in the sense that calm should return in the long term, but high prices will continue to persist in the short term. In particular, inflation will return to around 2%, Frankfurt’s target, between 2024 and 2025. It will still be above, but not as high as in 2022 and 2023. No sign of de-anchoring of estimates from expectations, according to the ECB.
Then there is the Qt chapter. That is, the shrinking of the Eurotower’s budget. It will start at the beginning of the second quarter of next year, as anticipated. “Starting from early March 2023, the Asset Purchase Program (APP) portfolio will be reduced at a measured and predictable pace, as the Eurosystem will only partially reinvest the principal payments from maturing securities. The pace of this reduction will average €15 billion per month until the end of the second quarter of 2023 and will then be determined over time. In other words, the passive Qt. This too will be gradual and subject to revision based on the data that will gradually arrive. At the February meeting “the Governing Council will communicate the details of the parameters for the reduction of the stocks of the App”. And “will regularly review the pace of the APP portfolio reduction to ensure that it remains consistent with the overall strategy and stance of monetary policy, to preserve market functioning and to keep money market conditions firmly under control in the short term.” period”. Furthermore, by the end of 2023, “the Governing Council will also review its operational framework aimed at steering short-term interest rates, which will provide information on the whereabouts of the balance sheet normalization process”.
The uncertainty is still high. And that’s why new “significant” rate hikes will come. In particular, the ECB explains, “Eurosystem experts have significantly revised upwards their inflation projections, which would average 8.4% in 2022 and then fall to 6.3% in 2023”. Inflation should record “a marked reduction during the year, to then settle on average at 3.4% in 2024 and 2.3% in 2025”. Net of the energy and food component, “inflation would average 3.9% in 2022 and increase to 4.2% in 2023, to then decrease to 2.8% in 2024 and 2.4% in 2025 ». On the GDP front, on the other hand, the current projections by Eurosystem experts indicate “an economic growth of 3.4% in 2022, 0.5% in 2023, 1.9% in 2024 and 1, 8% in 2025”.
All solved? Not really. This was pointed out by Kevin Thozet, member of the investment committee of the transalpine financial boutique Carmignac. “The risk of a more aggressive monetary policy is increasing: the ECB has expressed its fears for the future trend of inflation, believing that the recession will not be enough to tame the surge in prices,” he says. And since “PMIs have fallen to 47 (with 50 being considered a recession level, anticipating the actual contraction by 6-9 months), several fiscal support measures have been announced; the recession should therefore be less deep than initially expected». As a result, he warns, “the path to disinflation should become even longer, requiring an even tighter monetary policy.” In other words, new increases, albeit with a lower tenor than in the autumn, are taken for granted.
The ECB therefore aligns itself with the Federal Reserve and the Bank of England in slowing down the pace. All three central banks held back hikes this week after a 2022 characterized by unprecedented hikes. In the case of the Fed, it hit the highest rate in 15 years. In the case of the British counterpart, for 14 years. Now we enter the heart of the holiday season, the first with inflation this high in decades. The accounts will be done in late January and early February, with the first flash price data for December. And the hope is that there are no negative surprises.