A hawkish 50bp

At next week’s meeting, we expect the ECB to deliver a 50bp rate hike with a hawkish twist. Specifically, we expect the ECB to present key principles of the end to reinvestments under the APP process (in which reinvestments will almost come to a full stop) and an open-ended wording for more rate hikes to come. This will be a compromise, which we believe will be palatable to both hawks and doves.

Nominal rates have repriced lower since the latest meeting in October by almost 40bp (10y EA GDP-weighted yield), while inflation has increased somewhat and as a result the 1y forwards have repriced back to late August levels. We expect the hawks to use the easing of financial conditions in the past weeks to argue for a more aggressive calibration, as textbook would say that the current ECB stance is not particularly restrictive.

The European economy fared surprisingly well in Q3, but we expect the ECB to have a mild recession in its baseline staff projections. For inflation, we expect the new staff projections to only point to headline inflation at the 2% target in 2025.

We currently expect ECB rate hikes into Q1 next year, with the deposit rate peaking at 2.75%, but with risks skewed for more hikes.

A (hawkish) compromise

In the past couple of weeks, we have seen a resurfacing of the doves in the public debate on the monetary policy calibration. Ahead of the October meeting, when all GC members were zooming in on a 75bp rate hike, we did not hear much from the doves, but that has now changed, with notably Lane and Panetta arguing for a moderation in the hiking cycle pace. However, particularly Schnabel, Holzmann and Knot have been sending hawkish signals, with notably Schnabel being very vocal on a 75bp hike. Since the October meeting, we have also noted Lagarde choosing a more upbeat wording on wages (which admittedly also Lane adopted), from 'wages are picking up' last week compared to 'wages may be picking up' in October. That means with differing views, we expect the GC to strike a compromise at next week’s meeting. We expect the doves to focus on slowing the hiking pace to 50bp, with an agreement to continue to hike rates for as long as needed on a data dependent and meeting-by-meeting approach. This will be palatable to the hawks, as we expect them to get a more hawkish calibration on the end to the APP reinvestments.

Despite recession, 'stickily' high core inflation could remain a concern for the ECB for some time yet

Economic data since the September meeting highlight the rising recession risk for the euro area economy. Comments from various GC members suggest that a short recession this winter is increasingly becoming the consensus view, but also that a mild recession may not be enough to quell the above-target inflation pressures. Hence, we expect the new staff projections to reflect a weaker growth outlook for 2023 and 2024, with growth returning to potential in 2025. We remain gloomier on the economic outlook and see a real risk of a double dip recession, as lingering energy troubles, weaker foreign demand and tighter financial conditions will weigh on the euro area growth prospects.

Download The Full ECB Preview