Waiting for the hawkish decision of the ECB, which is dealing cards today

High inflation rates

In view of the unusually high inflation rates, decisive action is necessary, otherwise there is a risk of an upsetting inflation expectations. Should the central bank act too cautiously, it is possible that it will have to tighten its monetary policy even more later. As a result, the key interest rates will probably be raised by 75 bp today, especially as almost half of the council members seemed open to such a step.

In addition to the rate hike, the ECB is likely to change the terms of the TLTRO. As far as this program is concerned, the pigeons in the Council also support the change of the rules. From the point of view of commercial banks, the changed conditions increase the incentive to early repayment of TLTRO funds. Thanks to it, the excess liquidity (over EUR 4,5 trillion) will be reduced, and thus the ECB will be able to spend more time on quantitative reduction of its bonds (quantitative tightening of QT).

The decision will support the euro exchange rate?

Another move by 75 bp should support the euro's valuation. If this is accompanied by other issues tightening the monetary conditions, the support for the single currency may be more permanent. It is true that the size of changes in the parameters of the ECB's monetary policy is largely priced in by the market and the risks for the entire euro area have not been negated, therefore the appreciation potential for the single currency will be limited.

Even if the ECB is likely to have to revise its growth forecasts downwards in December, the current gas supply situation (mild temperatures, well-stocked gas storage) suggests that The ECB may still sound "hawkish" despite the weakening economy and pessimistic sentiment indicators. The key factor is how much the bank will emphasize its restrictive bias. At this point, it is less important how much the reference rate goes up today.

At the moment, the market focuses on subsequent decisions and looks for answers on the level at which the entire cycle may end. We can see that some central banks are starting to slow down the pace of changes in the cost of money (Canada, reports from the Fed). However, the ECB is late with its decisions, so I do not assume that the institution will announce a slowdown in the cycle in the near future.

Source: Łukasz Zembik, OANDA TMS Brokers