As expected, the ECB hiked its interest rates by 75bps, bringing the deposit facility interest rate to 1.50% and the main refinancing rate to 2.00%.

This is the sharpest and most aggressive rate hike by ECB. What we can conclude is that in just over three months, the ECB has raised 200bps. If we look at past trend, it took them about 18 months.

But our worry is that it may not do much to help the current situation. Much of the problem is related to rising energy prices, largely triggered by Russian President’s decision to limit natural gas supplies to European customers. Also, the easing of business activities post Covid pandemic-era coupled with higher food prices have pushed up prices.

Inflation in the euro area rose in September to 9.9%, up from 9.1% in August, well above the ECB’s 2% annual price stability target. Inflation remains far too high.

Meanwhile, we noticed a slight change in tone that appears to be dovish. ECB suggested it may only hike once more before ending its tightening cycle. That would represent a slightly more dovish stance, given that its President Christine Lagarde had guided for three or four hikes.

Should ECB change its stance, it would in turn reflect the sharp deterioration in the Eurozone economy caused by the economic fallout from the Ukraine war. The suspension of Russian gas shipments, in particular, has had a crippling effect on the energyintensive parts of the Eurozone's industrial base, especially Germany.

But we feel the change in wording is not an endorsement that ECB will not hike in 2023. It merely opens the door to a proper debate on this. And for now, we still expect for another 75-bps hike in December and followed by 50 bps in February and 25 bps in March. This would bring the deposit rate to 3.00%, reaching the terminal rate.

On the details about when ECB will start reducing its €8.8 trillion ($8.8 trillion) balance sheet, in a process known as quantitative tightening, ECB said that the conditions to take this step will be discussed in December.

They will be looking at three main factors: the inflation outlook, the measures taken so far, and the transmission lag — given that it takes a while for the monetary decision to have an impact on the economy.

The euro, which had hit a one-month high of $1.0094 versus the dollar earlier in the day, tumbled back below parity with the greenback after the ECB rate decision. The single currency clawed back some of its losses against the strong dollar, and was down 0.69% at 1.0011

Reasons for that drop include higher U.S. interest rates that attract money into investments priced in dollars and, more broadly, the dwindling prospects for Europe’s economy. Europe is facing headwinds from the loss of cheap Russian natural gas and an economic slowdown in key trade partner China.

Source: AmInvest Research - 28 Oct 2022