ECB will raise rates and reduce bank subsidies

Today, on Thursday, the European Central Bank (ECB) may raise interest rates again and, probably, even reduce subsidies for commercial banks, continuing the euro zone monetary policy tightening in order to fight outrageous inflation.

Fearing the entrenchment of rapid price growth, the ECB has already increased rates earlier in a record pace. The monetary police softening isn’t going to happen soon because it’ll take lots of time.

Supposedly, rates will grow by 75 basis points, cumulatively increased by 2% over the past three meetings, and it won’t be limited by this.

However, the ECB’s more essential decision will likely to become the bank’s intention to make first steps towards the cut of its 8.8 trillion euros balance sheet accumulated during the years of debt purchases and ultra cheap loans for commercial banks.

This problem is especially important because some banks that have received a loan at zero or even negative rates can now put this money back to the ECB for a positive and risk-free return, which increases with each rate hike. At the moment, the total amount of such loans is up to 2.1 trillion euros.

Unlike in September, now neither of the central bank’s representatives was opposed to a 75 basis points rate hike, thereby making markets expect the further monetary policy tightening.

Frederik Ducrozet, economist at Pictet, emphasized that political pressures cannot be ignored at the present time. For example, some countries have already introduced a certain tax on unexpected bank profits, as well due to the increase in interest rates.

The ECB's final decision on interest rate will be announced today at 12:15 GMT. Next, at 12:45 GMT, there will be a press conference led by Christine Lagarde, the central bank’s chairman.

The ECB's actions to tighten monetary policy may be justified by the fact that an excessive liquidity is keeping interest rates too low, therefore, money market rates are still below the central bank’s deposit rate.

The central bank’s decision is likely to change the terms of so-called Targeted Longer-Term Refinancing Operations (TLTROs), which will encourage banks to repay their loans early.

However, ING economist Carsten Brzeski suggested that changing TLTROs conditions could undermine trust in the ECB and make banks reluctant to use such refinancing system again.

The issue of a strategy to reduce the ECB's balance sheet by 5 trillion euros, consisting mostly of government bonds, will be even more controversial at today's meeting.

The issue’s decision is unlikely to be made on the spot, but the bank’s officials will likely to develop a plan to shrink the 3.3 trillion euro Asset Purchase Programme (APP) by suspending the investment of all cash received from maturing bonds in this program.