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Morgan Stanley (NYSE:MS) analysts projected that the European Central Bank (ECB) is set to persist with quantitative tightening (QT) as it transitions to a demand-driven floor system.
This comes amid heightened risks to the euro area’s economic outlook, with the expectation that the ECB will opt to adjust interest rates as a response, rather than employing its balance sheet.
In a statement, ECB President Christine Lagarde emphasized that the central bank’s role is not to fund defense and infrastructure expenditures. Morgan Stanley’s forecast suggests that excess reserves in the euro area could decrease to €2.5 trillion by the end of 2025.
According to the firm’s analysis, certain banking systems, including Italy’s, may need to augment their reserves before the year’s end.
The anticipated increase in reserve demand is likely to lead to a widening of front-end euro spreads, both in secured and unsecured markets. This is expected to occur as banks initially seek funding from the market and gradually increase their reliance on the central bank over time. This shift would happen as total reserves diminish and market rates ascend.
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