By Yoruk Bahceli
AMSTERDAM (Reuters) – Investors seeking to cash in on a policy pivot from the European Central Bank will watch Thursday’s meeting for any hint they should sit tight on bets for swift interest rate cuts next year.
Euro zone inflation is tumbling and the economy may be in a shallow recession, so traders don’t buy the ECB’s mantra that rates will stay high for some time.
“The biggest challenge will be to try and navigate around the amount of cuts and the speed of the cuts that’s been priced in,” said Ed Hutchings, head of rates at Aviva Investors.
Here are five key questions for markets.
1/ What can we expect this week?
The ECB is likely to say it is pleased that inflation, which exceeded 10% last year, is nearing its 2% target.
“They may even clearly tone down the language on the possibility of more hikes. So to the market they’d be saying: this is likely it, this is the peak,” said Jens Eisenschmidt, a former ECB economist and now Morgan Stanley’s Europe chief economist.
But don’t expect ECB chief Christine Lagarde to sound dovish beyond that; analysts reckon she will not want to fuel further expectations of policy easing.
2/ Is the inflation fight over?
The signs are certainly positive.
Euro zone inflation tumbled to 2.4% in November, undershooting expectations for a third straight month, with even the core measure excluding volatile food and energy prices falling sharply to 3.6%.
“The inflation picture is much more favourable than the ECB has in its forecasts,” said Carmignac chief economist Raphael Gallardo.
Inflation is expected to rise again as subsidies shielding consumers from high energy prices expire, however, while wage growth remains elevated. So the ECB will be reluctant to declare victory just yet.
3/ Who’s right on rates – traders or the ECB?
Traders now see over 130 basis points of ECB rate cuts next year, starting in March. When the ECB last met on Oct. 26, they priced in just 70 bps of cuts commencing in July.
Even board member Isabel Schnabel, a renowned hawk, has added fuel to the fire, telling Reuters the ECB can take further hikes off the table and should not guide for steady rates through mid-2024.
But wary of inflation risks, the ECB is all but certain to avoid endorsing market pricing, and many economists think March is too early for cuts.
“I expect a cautious, conservative, and moderately hawkish counter-reaction to the recent dovish market repricing,” said UBS chief European economist Reinhard Cluse.
4/ What’s happening to PEPP?
Lagarde recently said the ECB will “probably” discuss ending reinvestments under its 1.7 trillion euro Pandemic Emergency Purchase Programme (PEPP) earlier than the current end-2024 deadline, so the topic could come up this week.
Italian bonds, the main beneficiary, outperformed in November on rate cut hopes, sharply narrowing the risk premium they pay over Germany. But that has also boosted the case for bringing forward an end to reinvestments, analysts said.
Were the ECB to halt the reinvestments in June, Italy would miss out on some 15 billion euros of cash, compared to over 350 billion euros of debt it will sell next year, Pictet Wealth Management’s head of macroeconomic research Frederik Ducrozet, estimates.
For Ducrozet such a small amount isn’t worth risking volatility in markets right now. BNP Paribas nevertheless expects the ECB to start a formal discussion on ending reinvestments.
“What the decision may reveal is how much influence the hawks still have,” Ducrozet said.
5/ What will new ECB projections show?
Analysts largely expect the ECB to lower its growth and inflation projections for next year from September estimates, boosting the case for easing hawkish guidance, and inflation to be around 2% in 2026.
With inflation undershooting substantially, the ECB’s fresh staff projections, which will include forecasts for 2026 for the first time, are in focus.
(Reporting by Yoruk Bahceli; additional reporting by Dhara Ranasinghe, Naomi Rovnick and Stefano Rebaudo; graphics by Sumanta Sen, Pasit Kongkunakornkul, Kripa Jayaram and Riddhima Talwani; Editing by Dhara Ranasinghe and Catherine Evans)
