ECB to slow rate hikes and lay out plans to drain cash

The European Central Bank is set to raise interest rates for the fourth time in a row on Thursday, although by less than at its last two meetings, and lay out plans to drain cash from the financial system as it fights runaway inflation.

The ECB has been raising rates at an unprecedented pace to rein in prices that have soared since economies reopened after the Covid-19 pandemic, driven by supply bottlenecks and then surging energy costs following Russia’s invasion of Ukraine.

The central bank for the 19-country euro zone raised the interest it pays on bank deposits from -0.5 per cent to 1.5 per cent in just three months, reversing a decade of ultra-easy policy after being wrong-footed by the sudden rise in prices.

But Thursday’s policy meeting is likely to see this brisk pace of tightening slow as inflation shows signs of peaking and a recession looms.

A Reuters poll of economists expected the ECB to raise interest rates by half a percentage point after 75-basis-point hikes at each of its two previous meetings, mirroring the US Federal Reserve’s change of pace on Wednesday.

But like the Fed, the ECB is expected to flag even higher borrowing costs ahead to persuade investors it is still serious about fighting inflation, which could stay above the ECB’s two per cent target through 2025.

“We think the (ECB’s Governing) Council will be at pains to stress that the downshift should not be confused with an imminent end to the hiking cycle,” analysts at BNP Paribas wrote.

The Fed appeared to have pulled off a similar feat, with the US dollar rebounding after US central bankers said on Wednesday they expected to make further hikes and keep rates high for longer than earlier hoped.

Money markets were pricing in a 75 per cent chance that the ECB would raise the rate it pays on bank deposits to two per cent on Thursday before pushing it to roughly 2.75 per cent by March. The latest Reuters survey of economists saw the rate reaching that level by June.

The ECB is also expected to lay out plans to stop replacing maturing bonds from its 5 trillion euro portfolio, reversing years of asset purchases that have turned the central bank into the biggest creditor of many euro zone governments.

The move, which mops up liquidity from the financial system, is designed to let long-term borrowing costs rise and follows a similar step by the Fed earlier this year.

The ECB will announce its policy decisions at 1315 GMT and ECB President Christine Lagarde will hold a news conference at 1345GMT.

COMPROMISES

But Thursday’s discussion is likely to be heated after influential ECB board member Isabel Schnabel openly pushed back on the notion of smaller hikes advocated by chief economist Philip Lane.

“A key difficulty is that the ECB does not know how high it will have to go, reflecting huge uncertainty about both transmission and the inflation outlook,” Greg Fuzesi, an economist at JPMorgan, said. — Reuters