November 21, 2022: -The European Central Bank will keep increasing interest rates and may even need to prevent economic activity from inflation, ECB President Christine Lagarde said, which singles out rates as the bank’s key instrument regarding the balance sheet coming down.
The ECB has increased rates by an unprecedented 200 basis points from July to tackle inflation. It said more approach tightening is coming via rate hikes and reducing its 5 trillion euro debt holding.
“We expect to raise rates further, and removing accommodation may not be enough,” Lagarde stated in a speech at a conference.
“Interest rates are, and will be kept, the main tool to adjust our policy stance,” she added. “Acknowledging that interest rates stay the most effective tool for building our policy stance, it is okay that the balance sheet to normalise in a measured and predictable way,” she further said.
At 1.5%, the ECB’s deposit price is not far from the neutral rate, where the bank is stimulating nor stopping development. Most neutral rate estimates are between 1.5% and 2%, suggesting that “accommodation” will have been removed after an expected December hike.
The problem is that inflation, which runs at 10.6%, is far above the ECB’s 2% goal. Even a recession, now almost inevitable over the winter months, will not likely ease price pressures to let the ECB step away the brakes.
Investors have currently split amid pricing a 50 and 75 basis-point hike in December following back-to-back 75 basis-point moves and see the reduction of bond holdings, also called quantitative tightening, starting in 2023.
The ECB will outline plans for a balance sheet decrease in December, and the process is anticipated. To begin with, the bank will allow a few, but not all, bonds to end.
“The ECB is making sure that a phase of increased inflation does not feed into inflation anticipation, permitting too-high inflation to become entrenched,” Lagarde said.