There will be no peace for monetary policy but there will be a pause. The foreseeable parenthesis in the cycle of interest rate increases that the European Central Bank (ECB) will adopt this Thursday will turn the attention of investors, analysts and politicians towards a more complex and dangerous terrain for the markets: the reduction of the balance sheet and the Destination of the billion-dollar portfolio of public bonds that it built from the 2020 pandemic with the creation of the PEPP program, with which it purchased around 1.85 trillion euros in public and private fixed income.
Officially, the ECB maintains that it will stop reinvesting the yields on that debt at the end of 2024, but that was before it decided to raise interest rates vertically. Now the winds of economic slowdown, even recession, together with a marked disinflation on the price side point to a near future of lower rates that may make it unfeasible to reduce the central bank’s balance, which practically doubled from 2020 to 2022. .
During the second half of 2023, maturities and reimbursements worth 148 billion euros occur in the euro zone from the defunct APP program, which Mario Draghi launched in 2015 to stimulate inflation in the euro zone. The ECB said it would reduce stimulus by 15 billion monthly but is still buying debt with PEPP reinvestments. “It is very likely that it will announce the completion of these purchases earlier than estimated,” bank sources point out.
“We see the ECB’s first interest rate cut towards mid-2024 and expect at least two cuts of 25 basis points each next year. If inflation continues on a low path, increases will no longer be necessary, and the “Profitability of public debt, which has risen significantly, could begin to decline,” says Vontobel manager Claudia Wyss-Fontanive.
At more than 7 trillion euros, the ECB’s balance is almost two trillion euros below its maximum size, but remains well above its historical average and 50% above pre-pandemic levels. Most of the reduction occurred after the repayments of the banking liquidity open bar (TLTROs) that allowed credit to companies and households during the worst of the crisis of 2020 and 2021, although at the cost of sowing the ground for an inflationary wave.
Keep the tension on bonds
The governors of the ECB, meeting these days in Athens instead of in Frankfurt, will have to deal with the political pressures of some states that need the central bank’s crutch to finance themselves without their costs going out of control. The budget gap in some euro zone governments such as Spain or Italy and the consequent accumulation of public deficits that will force them to continue increasing the volume of issuance of their public debt at high rates will also focus part of the speech of the president, Christine Lagarde.
“The ECB faces a set of converging factors that suggest a reflective pause during its October meeting. The euro zone economy shows telltale signs of broad stagnation,” says Nicolás Malagardis, market strategist at the French management company Natixis IM. Solutions “Interestingly, on the pricing front, despite increasing energy price pressures and ongoing wage growth, companies have reported a slowdown in selling price inflation. These trends further reduce the urgency for the ECB to raise rates,” says this analyst.
The mystery of the types.
“The ECB, like other central banks, is in a position where its rate cycle is probably over. But it is still interested, barring a substantial change in the balance of the board, to keep yields high. bonds, thus allowing further tightening to put further pressure on prices. This requires a reiteration of an hawkish tone at this meeting and could also motivate the ECB to hint at an earlier end to reinvestments under the PEPP,” he said. lic the team of analysts who follow the ECB under the leadership of Carsten Brzeski, macro director at ING Research.
The mere possibility that the ECB is preparing to sell sovereign bonds in the current environment can counterbalance any buying movement by investors that would drive down yields and undermine the monetary tightening roadmap. “However, errors have not been uncommon in the bank’s recent attempts to provide rate guidance to markets and this time, the Governing Council and President Lagarde may prefer to shift focus to discussing policy tools.” . ethics not related to rates, refraining from offering more detailed guidance on the trajectory of interest rates,” they add from the Dutch entity.
At its meeting on September 14, the ECB raised the three reference interest rates by a quarter of a point. The main rate – at which banks finance themselves for one week – took it to 4.5%, its highest level since 2001. The credit facility – the central bank’s emergency window – to 4.75% and the deposit rate – the The remuneration that banks obtain for leaving their money in ECB accounts remained at 4%. In fact, experts now remember that this is truly relevant to financing costs for companies and households.
“The deposit facility interest rate is, today, the ECB’s reference rate to pay attention to. In recent years, it has been setting 50 basis points below the main operations interest rate of financing, which is, however, the one that is usually highlighted in the media,” Jaime Martínez Martín, head of Monetary Policy Strategy at the institution, explains in an article in the Bank of Spain.
In his opinion, the main rate was the reference until the 2008 crisis but since then the most appropriate for the interbank market – and financing in the real economy – is the deposit rate: “Looking to the future, to the extent But, for the moment, take note: the official ECB interest rate relevant to our loans and mortgages is the deposit facility rate, currently at 4%.”