The assets of the ECB will fall by 800 billion euros. Mexico also hiked today, well ahead of the Fed, preventing the peso from falling against the USD.
By Wolf Richter for WOLF STREET.
On Thursday, the S&P 500 Index fell 2.5%. It is down 5.0% since Tuesday morning’s surge. The Nasdaq fell 3.2% today. It has fallen 6.5% since Tuesday morning’s surge. In Europe, stock indices were deep red, with Germany’s DAX and France’s CAC 40 down over 3% on the day and down about 4.4% since Tuesday’s surge.
This comes after the Fed turned even more hawkish yesterday, hinting at a top interest rate above 5% and taking all rate cuts off the table in 2023, and after the ECB turned more hawkish this morning, climbing 50 basis points into recession that it did now, saying it was “obvious” that there would be a string of 50bp rate hikes despite a recession, and announced that the QT on bonds would start in March, having already started with the QT had started related to credits at the previous session, which has already resulted in a 9% decline in the balance sheet.
And it comes after the Bank of England announced a 50 basis point rate hike today, despite seeing a recession. And the SNB announced a 50 basis point rate hike and said it had sold foreign currency assets. And not to be left behind, the Bank of Mexico announced a 50 basis point hike. And all have more rate hikes on the table.
The ECB is now sliding into a recession, according to its own economic forecast. This recession is expected to be “relatively short-lived and shallow” from this quarter. But worse could come, according to ECB President Christine Lagarde, who added at the press conference that “risks to the economic growth outlook are on the downside, particularly in the near term”.
It raised its three key interest rates by 50 basis points: the deposit rate to 2.0%; the main refinancing rate to 2.5% and the top lending rate to 2.75%.
Rate hikes in a recession are very restrictive. And it revised its inflation outlook upwards.
“Interest rates still have to rise significantly and steadily to reach sufficiently restrictive levels…” Lagarde said, adding, “It’s pretty obvious” that “a steady pace means that we’re going to raise interest rates for a period of time at a… need to increase pace by 50 basis points”.
The ECB is struggling with raging inflation: headline CPI inflation is at 10%, non-energy CPI inflation is at a record 7.0% and some eurozone countries are over 20% and even Germany is at 11%. Inflation started to skyrocket in 2021 after years of mega-QE and negative interest rates. And suddenly it’s a huge mess.
QT on bonds starts in March 2023, it said today, by shedding €15 billion worth of bonds per month through 2023. The pace of subsequent declines “will be determined over time.” Details would be announced after the February meeting, it said.
QT related to loans already started at its October meeting to “help manage unexpected and exceptional increases in inflation,” as it said at the time. To that end, it has made the terms of its targeted longer-term refinancing operations (TLTRO III) less attractive to banks, which would accelerate bank exits from these loans.
These loans have dates when they can be repaid, and two of those repayment dates have already passed:
- In November, the banks repaid 296 billion euros to the ECB, which were booked on the ECB’s balance sheet on November 25th.
- In December, banks returned 447 billion euros in loans that have not yet been booked but will be booked in December.
This settlement of TLTRO III was the main factor in reducing total assets by €803 billion, or 9.1%, from the June peak. The green line is my estimate of the next balance sheet based on the announced €447 billion cut in TLTRO III. The balance sheet total falls to around 8.03 trillion euros:
The Bank of England also slid into a recession, up 50 basis points today to bring its policy rate to 3.5%. Citing its monetary policy report, it said that “the UK economy is likely to be mired in recession and CPI inflation for an extended period [currently 10.7%] was expected to remain very high in the near future.”
The Swiss National Bank sold foreign currency investments and increased its key interest rate by 50 basis points to 1.0%, after its 75 basis point hike in September and its 50 basis point hike in June, and put further rate hikes on the table. Gone is the negative policy rate of -0.75%.
You are doing this to counteract “increased inflationary pressure and further spread of inflation”. Inflation in Switzerland was 3.0% in November and “is expected to remain high for the time being,” it said.
“We have been selling FX in recent months to ensure decent monetary conditions. Going forward, we will continue to sell FX whenever it makes sense from a monetary policy perspective,” SNB Chairman Thomas Jordan said in his speech. This follows his announcement in June and September that the SNB would do so.
And the SNB did it. As we know from the SNB’s SEC filings, it sold hundreds of thousands of shares of its largest holdings in U.S. stocks Apple, Microsoft, Alphabet, Amazon and Meta during the second and third quarters. And it has suffered massive losses as asset prices have fallen in its vast portfolio of foreign-currency-denominated securities.
The Bank of Mexico migrated Up 50 basis points today to 10.5% after four consecutive rises of 75 basis points, in line with the Fed. Core inflation in Mexico rose to 8.5%.
The Bank of Mexico started raising 4.0% in mid-2021, nearly a year ahead of the Fed, to stay ahead of the Fed, similar to Brazil and some other central banks. They did this to deal with domestic inflation and to support their currencies against the USD.
what worked. In the 18 months of rate hikes, the Mexican peso has appreciated against the USD while laggard currencies like the ECB and Bank of Japan have watched their currencies take a hit.
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