Christine Lagarde, President of the European Central Bank.
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FRANKFURT – The European Central Bank is meeting this week with investors watching closely to see when the Frankfurt institution might start cutting interest rates.
It will be too early to declare victory in the battle against inflation, but with inflation at its lowest levels in two years, this will certainly give the ECB’s Governing Council some breathing room to focus on another important issue: its massive balance sheet.
“Having reached an interest rate plateau at a 4% deposit rate, the ECB can now shrink its balance sheet at a faster pace without risking a major explosion in yield spreads within the eurozone,” Holger Schmieding of Berenberg said in research. Note to customers.
“However, markets will likely have to correct some of their overly optimistic expectations for interest rate cuts once the ECB speaks on Thursday.”
Inflation fell to 2.4% in November, and core inflation also declined. With inflation falling faster than expected, investors have increased their bets on interest rate cuts by the European Central Bank next year, especially after Isabel Schnabel, one of the more hawkish members of the Governing Council, described the slowdown in consumer prices as “noticeable” and a “pleasant surprise.” “. According to the transcript of December 1 Interview with Reuters.
Money markets are currently pricing in roughly 150 basis points of interest rate cuts next year. The bank’s prime deposit rate reached a record high of 4%, after 10 consecutive increases that began in July 2022 and pushed interest rates into positive territory for the first time since 2011.
“The risk now is of earlier and deeper cuts, and the ECB is more able to decouple from the Fed,” said Mark Wall, ECB watcher at Deutsche Bank.
But he believes the ECB will likely keep its cards close to its chest: “We expect the ECB to maintain its guidance that keeping interest rates tight for a sufficient period will bring inflation back to target in due course.”
Looking ahead, there will be a new round of staff forecasts for inflation and economic growth in March, which will give the central bank more data to support its data-driven policy approach and perhaps give it room to cut interest rates.
But this week, the major policy change at the conclusion of the ECB’s meeting on Thursday could come in the form of a shift in forward guidance – specifically when it ends the reinvestment of its PEPP programme.
PEPP, or Pandemic Emergency Purchase Program, is a flexible bond purchasing program introduced during the coronavirus pandemic. The ECB reinvests any outstanding securities it receives from its PEPP portfolio, but this may soon change.
“We have indicated that we will continue reinvesting until at least 2024,” European Central Bank President Christine Lagarde told European Parliament lawmakers on November 27.
He added, “This is an issue that will likely be raised for discussion and study within the Board of Directors in the not-too-distant future, and we will likely reconsider this proposal.”
“If interest rate cuts go ahead, the ECB may accelerate initial steps to exit the ERPP reinvestment,” Deutsche Bank’s Wall explained.
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