It has raised rates by a total of 125 basis points (bps) since July, the fastest rate of policy tightening on record.
Recession risks are unlikely to hold for now, but markets are watching for signs of when a break may be coming.
“The central bank has no choice but to make another big rate hike and look hawkish,” Nordea chief analyst Jan von Gehrich said.
Here are five key issues on the market’s radar.
1/ What will the ECB do this week?
Economists polled by Reuters expect the rate to rise 75 basis points to 1.5%, reflected in market prices. Politicians favored a sharp rate hike, with most favoring 75 basis points.
The ECB may announce a possible change to the rules governing cheap long-term loans, targeted long-term refinancing operations (TLTROs).
Investors will also be looking to ECB chief Christine Lagarde to see how the ECB views the trade-off between recession risks and inflation and when it might end tightening.
“It makes sense to expect a 75 basis point rate hike, signals of ECB balance sheet reduction and changes to TLTRO rules to reduce excess liquidity,” said Francis Yared, global head of risk management at Deutsche Bank Rates Research. “It is not clear how much of this the ECB will announce (this week).”
The ECB is ready to conduct another large-scale rate increase
2/ Are there signs that inflation has peaked?
Economists say it is too early to tell of a spike in inflation, but the likelihood that it will happen in the near future is growing. Inflation accelerated to almost 10%, a level not seen in some Eurozone countries for more than 70 years.
One reason for optimism is that gas prices in Europe are down 65% from their peak in August.
While peak inflation may be close, unless there are additional shocks related to the war in Ukraine, the decline will be slow at first, said Boshtyan Vasle, the ECB’s policy chief.
Another problem is that inflation is broad-based, so even if headline numbers fall, underlying price increases will remain uncomfortably high.
The jump in inflation is critical to determining whether policymakers need to push rates beyond the neutral range — where they neither stimulate nor dampen growth — a rate usually pegged at 1.5% to 2%, but which some policymakers rated too low.
Inflation in the Eurozone is reaching its peak?
3/ Are we going to get QT?
Not immediately. But the ECB may refine its language on reinvestment and provide more details in the coming months.
The next key policy debate will be how to drain the more than €5 trillion of bonds on the ECB’s balance sheet in a process called quantitative easing (QT).
Bundesbank President Joachim Nagel and Dutch central bank chief Claas Noth said the time for QT, which is part of a broader policy tightening, is drawing to a close.
The era of easy money is over The era of easy money is over
4/ Is the ECB handing out cash to banks and what will it do with it?
Eurozone banks are sitting on €2.1 trillion in cash, which the ECB issued at ultra-low, sometimes even negative, rates in an effort to stimulate the economy.
But the rapid and significant rate hikes mean banks can keep that cash at the ECB for a risk-free profit, angering politicians who see it as manipulation of the system.
Politicians are believed to be close to reaching an agreement on changes to bank lending rules that will cut tens of billions of euros in potential bank profits. A decision may be made on Thursday.
Who benefits from the monetary donation of the ECB? Who benefits from the ECB bonus?
5/ To what extent is the ECB concerned about financial instability?
Aggressive interest rate hikes by major central banks and a rout in UK bonds have raised concerns about financial instability.
The International Monetary Fund said risks to financial stability had risen “significantly” and Ms Lagarde warned that markets could be overly optimistic about the economic outlook, raising the risk of a sharp market correction.
“The critical issue for markets is financial stability,” said Flavio Carpentzano, director of fixed income at Capital Group, although he does not expect the ECB to address it directly.
(Concern about financial stability
life risks are increasing