LONDON (Reuters) - The European Central Bank raised interest rates again on Thursday and signalled it was keen to start shrinking its bloated balance sheet, taking another big step in tightening policy to fight off a historic surge in inflation.
The ECB also cut a key subsidy to banks, but made no hint about plans to start winding down its bond holdings after hoovering up trillions of euros of debt issued by euro zone governments since 2015.
The euro dropped to a session low after the decision and was last down around 0.7% at $1.0005.
Germany's 10-year Bund was last down 2.5 basis points on the day at 2.09% versus 2.195% before the decision, while the pan-European STOXX 600 index remained lower and was last down 0.35%.
JACK ALLEN-REYNOLDS, SENIOR EUROPE ECONOMIST, CAPITAL ECONOMICS, LONDON:
"The ECB is very likely to follow today’s 75 bps rate hike with further aggressive increases in the coming months, even if we are right that the forthcoming recession will be deeper than most expect. The decision to maintain the guidance on APP reinvestments, rather than announce the beginning of QT, is likely to be seen as slightly dovish. But with policymakers openly discussing QT, it wouldn’t be surprising if an announcement came at the next meeting in December."
PIET CHRISTIANSEN, CHIEF ANALYST, DANSKE BANK, COPENHAGEN
"I think the market rally is due to indications of a slowing rate hike pace but also that we didn’t have any changes to the QT wording. The latter is probably the most surprising to me."
VIRAJ PATEL, GLOBAL MACRO STRATEGIST, VANDA RESEARCH, LONDON
"The ECB is living on the edge of a dovish pivot. It’s clear that this is a central bank that wants to front-load rate hikes to control inflation. But they are also wary that they are not in control of a lot of external growth and market factors that can act as a circuit-breaker to the hiking cycle.
"The knee-jerk reaction of lower swap rates and euro shows the slight dovish tilt to the statement. But worth remembering that this is still a central bank that will hike aggressively in the face of a recession – and the only thing that will stop them is if they see the whites of eyes of either (a) lower inflation or (b) a market crisis. If that doesn’t happen, then continue to expect front-loaded hikes from the ECB… and even another 75bps in Dec."
JEREMY BATSTONE-CARR, EUROPEAN STRATEGIST, RAYMOND JAMES:
"The European Central Bank is between a rock and a hard place as it looks to control inflation without tanking the economy, and has decided that potentially tipping the region into a recession is a necessary evil in order to control spiralling inflation.
"The euro zone is facing challenges that will be familiar to much of the rest of the world, with headline regional inflation running at a year-on-year rate of 10%, five times the target level. In response the ECB has raised its base interest rate by a further 0.75 points as it prioritises its core mandate of ensuring price stability. However, the attempt to cushion the blow to households and businesses from rising costs is likely to create issues elsewhere by imparting a marked downward pressure on economic activity by dramatically increasing the cost of borrowing."
CHRIS SCICLUNA, HEAD OF RESEARCH DIVISION, DAIWA CAPITAL MARKETS, LONDON:
"They’ve dropped the reference to the next several meetings in the statement (they had previously said over next several meetings the Governing Council expected to raise interest rates further), which is probably an indication of a slower rate increase in December.
"The TLTRO decision is a questionable one – the change in the terms and conditions after the events raises question marks about predictability on policy moving forwards. You would presume given the downturn they would want to use a tool like this in the future, and if they play around with the terms and conditions that might be harder, but we'll want to look at the details later."
ALTAF KASSAM, EMEA HEAD OF INVESTMENT STRATEGY AND RESEARCH, STATE STREET GLOBAL ADVISORS, LONDON
"This move shows the ECB continuing to respond to criticism of falling behind the curve, especially with respect to the Fed, and also to growing calls for the need to put a floor under the euro, in an effort to keep a lid on the extra imported (especially energy price) inflation its weakness has brought.
"That said, this second 75 bps move takes the deposit rate into the middle of the 1-2% range for the neutral rate that ECB officials have cited, which should provide a natural point to slow down the pace of hiking given the high likelihood of a Q4 eurozone recession. As a result, we expect the ECB to slow its pace of rate rises, hiking ‘only’ another 50 bps in December – yielding a deposit rate of 2% by year-end."
BEN LAIDLER, MARKET STRATEGIST, ETORO, LONDON:
"The TLTRO changes and the 75 bps hike was pretty much consensus so therefore priced by the market.
"Focus will be on the press conference because with market expectations rising that the Fed will ease back on rate hikes... so people are going to be reading the tea leaves very carefully from what Lagarde says for the chances of a deceleration in rate hikes in the future.
"I think we've probably got another 75 bps hike at the next meeting but markets are going to be looking very carefully at the guidance for what is coming after that."
CARSTEN BRZESKI, GLOBAL HEAD OF MACRO, ING, FRANKFURT:
"In slightly more than three months, the ECB has now hiked interest rates by a total of 200 basis points. It's the sharpest and most aggressive hiking cycle ever.
"At the current juncture of a looming recession and high uncertainty, normalising monetary policy is one thing but moving into restrictive territory is another thing. With today’s rate hike, the ECB has come very close to the point at which normal could become restrictive."
NEIL BIRRELL, CHIEF INVESTMENT OFFICER, PREMIER MITON INVESTORS, GUILDFORD, UK:
"The ECB increased rates to 1.5%, exactly as expected, and has said they are going higher, which shouldn’t be a surprise given that inflation is almost 10%. Central banks everywhere will be looking at the economic data and will make decisions accordingly. They won’t want to overdo it and damage their economies more than they have to. But, let’s be clear, inflation is the primary fear, not recession, and beating it is the most important battle to win. For now, it’s difficult to see what level the ECB will see peak rates reaching."
MARCHEL ALEXANDROVICH, EUROPEAN ECONOMIST, SALTMARSH ECONOMICS, LONDON:
"It (the rate decision) is broadly in line with expectations and the ECB is signalling more rate hikes will be required.
"The more interesting thing for us is the balance sheet and where normalisation goes. There's not a huge amount here but they are trying to make it less attractive for banks to borrow from the ECB and park it back at the ECB. So, they are pushing banks to pay their TLTRO loans early.
"They have been pushing up rates since July and now they are saying they are ready to drain the liquidity out of the system."
MICHAEL HEWSON, CHIEF MARKET STRATEGIST, CMC MARKETS, LONDON:
"At the end of the day there may be a softening of the tone from the ECB, certainly the sell-off in the euro would appear to suggest that they’re not going to go as aggressively over the course of the next few months.
"I think the devil will be in the details. But certainly the tone of it suggests they’re may be getting nervous about over tightening and the initial reaction would appear to suggest that perhaps we may not get 75 basis points in December."
(Reporting by the London Markets Team, editing by Dhara Ranasinghe)