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Summary • With sizeable TLTRO maturities this year and TLTRO-created reserves all but disappearing less than a year from now, reserves in the Italian banking system will fall to uncomfortably low levels before an acute shortage emerges in early 2024. Already next June, we estimate that the Liquidity Coverage Ratio of significant banks in Italy will fall by 50 percentage points By March 2024, it will be below 100. The ECB will judge this situation to be unwanted and unwarranted, forcing it to act. • The ECB will find itself at a crossroads by the coming summer. We see three options ranked in order of likelihood: • In the second half of 2023, the ECB will take a leaf out of Bank of England’s playbook. The ECB will align its deposit rate with its main borrowing rate, the MRO rate. This will allow the ECB to seamlessly cover both anticipated and unanticipated reserve shortfalls in parts of the Euro Area banking system while shrinking its balance sheet with Quantitative Tightening and TLTROs as they come due. More importantly, the ECB will prevent a bifurcation of money market rates between member states where bank reserves are relatively high and where they are relatively low. At the same time, the ECB will keep its operational framework simple and prevent US-like liquidity crunches; • Stick with the current framework, which will further fragment monetary policy transmission, but which will still prevent a liquidity crunch while preventing potential communication problems surrounding aligning the deposit rate with the MRO-rate; • A blast from the past: 1-week deposit tenders or their newer version: 1-week ECB certificates. The ECB would pay a heavy price for mopping up reserves where they are most plentiful: in the core Euro Area countries. The national central banks will experience increased operating losses, while risks of a US-like money market breakdown rise. • In each scenario, we see odds of the ECB instituting a standing facility for nonbanks as very, very remote. • Regardless, because of TLTRO repayments and Quantitative Tightening, the ESTR-deposit rate spread should narrow markedly in the second half of the year.

Summary • With the ‘Angst of the Month’ – the failure of SVB bank and Credit Suisse – firmly in the rearview mirror, expect the ECB to rediscover its hawkish mojo. Relatively speaking of course, because this is the Lagarde ECB after all, not the Weidmann ECB that could have been (more on that on the final page); • Our call: despite a 50bps rate hike back firmly on the table, we expect a compromise: a 25bps hike on Thursday May 4, but with hawkish guidance that there is no stopping the rate hike train yet. The ECB will tee up another quarter point hike for the June meeting. And Lagarde & Co will lean towards more hikes over the summer. Core inflation and wage growth are simply way too high, offsetting improvements in the data elsewhere; • Everything revolves around core inflation. Just two days before the meeting we will get the preliminary inflation figures for April. Furthermore, the ECB will pay close attention to the Bank Lending Survey that is released the same day. Thus, our call can become obsolete very quickly; • This report is divided in two parts. In the first three pages we discuss the economic backdrop that functions as the input to the Governing Council’s decision. Readers who are less interested in the economic raison d'etre of our call can simply skip to the final paragraph on page 4 and read two more pages on the nitty gritty of the meeting.