ECB preview - Depo rate to be hiked by 75bp, reverse tiering a possibility
We expect the ECB to raise its policy rates by 75bp following its meeting later this week. This is larger than the 50bp rate hike that we previously expected.
The larger expected hike reflects:
1. The hawkish comments from the majority of Governing Council officials over the last few days
2. Headline inflation has continued to accelerate, while the drivers of price pressures have generally been more elevated than the ECB expected in June. For instance, the euro has weakened further
3. GDP in the first half of this year has come in higher than the central bank expected
4. The shift in market pricing and analyst forecasts means that a larger move would not be a shock (even though such a move is not fully priced)
We will re-assess our medium term outlook for the ECB after the September meeting. However, our thinking right now is that we will see a total of 75bp of rate hikes after that. That could come in one further step of 75bp in October, or be spread out over October and December. We still expect an ECB pivot around the turn of the year, reflecting our judgement that the eurozone economy is heading for significant contraction.
Reverse tiering a possibility - The ECB could also be minded to take steps to reduce the income banks can earn from parking the large amounts of excess liquidity that have built up (due to asset purchases, TLTRO and household savings) in its deposit facility. The ECB may decide that a proportion of those excess reserves would not be subject to the deposit facility rate, but rather a lower rate, and possibly 0%. This would be the mirror image of the system it introduced in autumn of 2019, where a proportion of excess reserves where not subject to negative deposit rate, in order to reduce the cost burden to the banking system (). The exempt tier was determined as a multiple (introduced at 6) of an institution’s minimum reserve requirements. A similar system could be introduced this time, though the exact framework is uncertain. For instance, it could be a proportion of excess reserves, rather than a multiple of required reserves. The ‘exempt tier’ back then, as for any future scheme, can not be very large. This is because if the majority of excess reserves were to be exempt from the deposit facility rate, then that rate would not fully be passed through into money market rates. As a result, it would water down the impact of the ECB’s rate hikes. (Nick Kounis & Aline Schuiling)