The European Central Bank Faces Key Questions
The European Central Bank (ECB) has good reasons to hold fire on Thursday after raising interest rates at its past 10 meetings. However, conflict in the Middle East, pushing energy prices higher, is another challenge for the central bank. Traders are keen for a sense of how long borrowing costs will stay high.
The ECB will need to strike a balance between avoiding an aggressive hawkish stance and keeping the door open for rate hikes. ING’s global head of macro, Carsten Brzeski, states, “The biggest challenge will be to keep a balancing act — not sound aggressively hawkish but keep the door open to rate hikes.”
Question 1: What can we expect this week?
The ECB has signaled a pause, and markets do not anticipate further rate hikes. However, the central bank is unlikely to rule out another rise. ECB Chief Christine Lagarde may continue with the high-for-longer mantra that has pushed up long-dated bond yields. Although the weakening economy suggests limited need for further tightening, the ECB is expected to push back against rate-cut speculation.
Question 2: Will the ECB discuss quantitative tightening?
The ECB is not expected to start active bond sales soon. Instead, the debate centers on whether to bring forward the December 2024 end-date for reinvestments from the Pandemic Emergency Purchase Programme (PEPP). Many favor this option, but rising Italian bond yields could cool talk of a quick end. Under PEPP, reinvestments can be skewed to countries most in need, which helps prevent fragmentation.
Question 3: What does a fresh rise in energy prices mean?
European gas prices and oil prices have surged, threatening to push inflation higher. Europe, being an energy importing region, is more vulnerable than the United States to an inflation spike caused by Middle East tensions. However, Lagarde is likely to avoid discussing energy prices until it becomes clear if the run-up will be sustained. The ECB expects headline inflation to ease in the coming years.
Question 4: What does the ECB do if things go wrong with Italy?
For now, the ECB is not expected to intervene even as higher deficit forecasts push up Italian borrowing costs. The Transmission Protection Instrument, a bond purchase scheme to help more indebted states and prevent fragmentation, joined the toolkit last year. However, sources suggest there is no rush to utilize this instrument.
Question 5: What about tighter financing conditions?
The ECB will scrutinize September’s bank lending data to assess tightening in financing conditions. The amount of money circulating in the euro zone shrank significantly in August due to reduced lending and increased savings. Surging U.S. Treasury yields have also influenced European borrowing costs. These factors support the case for no further rate hikes.
The ECB faces key questions regarding its future decisions. While the market anticipates a pause in rate hikes, the central bank must carefully balance its messaging to avoid sounding too hawkish or signaling rate cuts. The discussion around quantitative tightening and the impact of rising energy prices adds complexity to the decision-making process. Furthermore, the ECB’s approach to Italy’s financial challenges and the assessment of tightening financing conditions will shape its future actions. These questions remain crucial for traders and investors as they seek clarity on the central bank’s stance.
