ECB’s Targeted TLTRO Tweaks Set to Drain Excess Market Liquidity

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UK Market Update

The fallout from September’s UK “mini budget” led to the resignation of Chancellor Kwasi Kwarteng and then Prime Minister Liz Truss. Jeremy Hunt replaced Kwarteng as Chancellor and reversed most of the fiscal loosening his predecessor had announced. Former Chancellor Rishi Sunak was named the new PM, with Hunt retained as Chancellor in Sunak’s Cabinet reshuffle. The Bank of England (BoE) launched a Temporary Expanded Collateral Repo Facility to ease liquidity pressures facing liability-driven investment (LDI) funds. To further quell market volatility, the bank expanded its purchases to include inflation-linked gilts in its mandate. The UK’s CPI print of 10.1% saw a significant increase in food and raw materials. Throughout October, the UK’s end-of-year implied interest rate fell from 4.63% to 3.57%.

Eurozone Market Update

The European Central Bank (ECB) raised rates by 75 bps, taking the deposit rate to 1.5%. The meeting was perceived as dovish, with President Christine Lagarde highlighting that “the Governing Council has made substantial progress in withdrawing monetary policy accommodation”. As anticipated, the ECB tweaked the terms of its targeted longer-term refinancing operations (TLTRO) loans, adjusting the interest rates of TLTRO III to the average key rate from 23rd November onwards, with three additional voluntary repayment dates. This move aims to reduce excess liquidity in the system (see Chart of the Month) and free up collateral. Pandemic emergency purchase programme investments will continue until 2024, while the asset purchasing programme will continue as long as required. Inflation remains high — 9.9% in the euro area — driven by energy (up 40.7%) and food (up 11.8%).

US Market Update

Federal Reserve members remained adamant that they would do everything required to bring down inflation. However, the Wall Street Journal reported that the Fed would likely begin to consider easing back on the magnitude of hikes while maintaining their aggressive posture. The expectation is that the Fed will still raise rates by 75 bps in November, but the expectation for December has trended closer to 50 bps rather than 75 bps. The Consumer Price Index showed headline inflation growth beat expectations for September (0.4%) and annually (8.3%). More troubling was the core component, which was up 0.6% on the month and 6.6% annually, the firmest reading since 1982. Rises in non-farm (263,000) and private payrolls (288,000) beat expectations, while the unemployment rate dropped to a cycle-low 3.5%.

Looking Ahead

Both the Fed and BoE meet in early November. We expect both to increase rates by 75 bps, but communication will be vital for any indication of a pivot for future rate hikes at a slower pace. This follows the more dovish shift from the ECB, alongside lower-than-expected rate hikes by both the Reserve Bank of Australia and the Bank of Canada. The UK’s delayed budget on 17th November will see Sunak and Hunt scrambling to plug the gap in public finances caused by surging inflation and soaring interest rates. If successful, this will calm UK markets, likely resulting in the BoE hiking less than the market has priced in. Following the ECB’s TLTRO announcement, we will watch for any early repayments at the first additional voluntary repayment date on 23rd November. Any large repayment may result in modest upward pressure on short-term interest rates.

Chart of the Month: Excess Liquidity Set to Drain with ECB's TLTRO Loan Changes

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