Market alert: What will ECB do❓

ECB expected to deliver another 75 rate hike on Thursday❗

Rate decision from European Central Bank is one of the top macro events of the week. The ECB will announce its next decision on Thursday at 1:15 pm BST and a big rate hike is expected. However, attention will be not only the decision tomorrow but also where the rates will go next. Take a look at our preview of the event!

Another 75 basis point rate hike coming?

The European Central Bank is expected to deliver another 75 basis point rate hike on Thursday this week. Such an outcome is expected by 48 out of 50 economists in a Bloomberg poll. Also, money markets currently price-in 73 basis points of tightening, signaling that any move other than a 75 bp hike will be a big surprise. However, it looks rather unlikely. Unlike it was the case before previous meetings, there was virtually no arguing among ECB members on the size of the incoming rate hike. This strongly suggests that a 75 bp rate move tomorrow may be a done deal already.

Money markets almost fully price-in a 75 basis point ECB rate hike at Thursday meeting. Source: Bloomberg

How high will ECB rates go?

Having said that, when it comes to rate, attention will be mostly on what comes next. A clear guidance is unlikely but some hints may be offered. Francis Villeory de Gallhau, French central bank chief and ECB member, said that ECB could hike rates to 2% by the end of the year. It would mean slowing tightening with a 50 bp rate hike on the final ECB meeting on December 15, 2022. Also ECB Chief Economist Philip Lane pointed to the neutral rate being slightly above 2%. Economists in the Bloomberg survey seem to agree with Lane as they now expect terminal despoit rate to be at 2.5% and to be reached in March. However, there is a strong expectation that ECB will slow the pace of rate hikes after today's meeting by going for a 50 bp rate move in December and 25 bp rate hikes at the subsequent 2 meetings.

Economists polled by Bloomberg now see the terminal ECB rate at 2.5%, reached at the end of Q1-2023. Economists saw the terminal rate at 1.5%, reached at the December 2022 meeting, in a poll from September. Source: Bloomberg

What about quantitative tightening?

There was some chatter on the markets about potential launch of quantitative tightening. Such chatter came after it was reported that the ECB started to discuss the possibility of reducing its balance sheet. However, QT is likely to remain a topic of discussion rather than a course of action for the time being. ECB President said last month that QT will begin in due time but she also said that it will begin after rates reach a neutral level of higher, and we are not there yet. Also it is not yet known whether ECB will decide to shrink its balance sheet by active bond sales or simply by not reinvesting maturing securities. However, as we have said - decision on QT launch and the launch itself is likely still some time away.

Nevertheless, excess liquidity is an issue that needs to be addressed. ECB may decide to change terms of TLTRO loans that are generous compared to current market rates. However, while ECB already said that change would be legally feasible, it could undermine ECB credibility, which may lead to long-term reputational damage. Another way to deal with excess liquidity could be to reinstate the tiering system on excess reserve holdings. Tiering system means that some of a bank's reserves could be deposited at a rate other than ECB deposit rate. However, the impact of such measures would depend on scope and tiering details.

ECB surprised a lot this year

Last but not least, while ECB has traditionally been a rather dovish and predictable central bank, this year is an exception. ECB delivered hawkish surprises at almost every meeting in 2022 so far, be it in case of rate decision or accompanying statement. As inflation in the EMU sits at 9.9% YoY, further action is needed and the chance of a dovish U-turn looks slim. Traders should keep that in mind heading into the ECB meeting tomorrow.

EURUSD jumps above parity, DE30 looks towards trendline

EURUSD jumped back above parity this morning. While more and more hawkish expectations regarding ECB rate path are playing a role in the move, it is mostly driven by weakening of the US dollar. Nevertheless, it will mostly be up to the ECB whether the move above 1.00 lasts or not. A rate hike smaller than 75 basis point could be a trigger for a pullback. From a technical point of view, we may be witnessing a bullish trend reversal on EURUSD as the pair broke the downward trendline and is making the largest upward correction in the current downward impulse.

EURUSD at D1 interval. Source: xStation5

European equity markets also caught a bid as of late. DE30 looks to be heading for a test of the downward trendline that has been limiting upward moves for almost half a year. However, even if a break above occurs, bulls will have another obstacle to tackle to brighten the outlook - upper limit of the Overbalance structure at 13,445 pts.

DE30 at D1 interval. Source: xStation5