Will the ECB slow down?

Next week, the ECB Governing Council will decide on the next interest rate step. The decision will be a rate hike of 50 or 75 basis points (bp). The public statements of the members were different during the last few weeks and did not give clear indications on the amount of the coming interest rate step. The environment remains difficult to assess. There are considerable uncertainties. Inflation has probably peaked and the economy is weak. However, it remains to be seen how many companies will pass on increased costs or take advantage of the situation and thus continue to fuel inflation, at least for the time being. The level of wage settlements is also a risk factor. So far, however, wage settlements are still within the ECB's expectations. Finally, it is still unknown what impact the interest rate hikes to date will have on the economy.

Depending on the weighting of these factors, the assessment will be whether a smaller rate hike is already appropriate after two rate hikes of 75bp each or not. We expect a majority in favor of a 50bp rate hike next week. An additional argument in favor is that the ECB's decision to change the terms of the TLTROs has already initiated early redemptions and thus a reduction in liquidity. This will be compounded by the fact that a roadmap for reducing the APP portfolio is likely to be decided next week. This has risen to EUR 3400bn as a result of earlier ECB securities purchases. Until now, current redemptions have been reinvested, thus keeping the size of the portfolio constant. On average, these redemptions amount to just under EUR 25bn per month, which is probably the maximum possible reduction of the portfolio. Theoretically, it is conceivable that the ECB will also sell securities in order to achieve a faster reduction of the portfolio, but this is very unlikely, in our view. We expect the reduction of the portfolio to start in April, due to the lack of reinvestments.

Finally, new forecasts from ECB economists will also be available. We expect the biggest change from the September forecasts to be in GDP growth for 2023, which will probably be revised downward close to zero. Inflation forecasts for 2023 could be revised slightly downward, as the September forecast assumed a much higher gas price. However, these revisions will hardly play a role in the ECB's further course. More exciting will be the ECB economists' expectations for 2025, which will be published for the first time next week. The issue is whether the inflation target of 2% is expected to be reached by then. To be sure, the result does not provide any compelling guidance for monetary policy. But depending on how it turns out, it supports the case for a tighter or softer monetary policy stance by the ECB.

The market also expects a 50bp rate hike next week.

How far will US interest rates rise?

One day before the ECB, the US Fed will decide on the key interest rate. Uncertainty about the outcome is much lower than at the ECB. Indications, not least from Fed Chairman Powell, point to a high probability of a further interest rate hike of 50 basis points (bp). The outlook will be more exciting. After the meeting, the new survey of meeting participants of the committee deciding on monetary policy (FOMC) will be published. The last survey on the development of the key macroeconomic indicators dates back to September and Fed Chairman Powell has already announced that interest rate expectations have shifted upward since then. The median expectation in September was for rates equivalent to a 50bp rate hike next week, but to only 25bp for 2023, i.e. for the January/February meeting. The market is currently pricing in 50bp for both sessions, for a total of 100bp before the peak in this rate cycle is reached. This is also in line with our expectations. Thus, the market is already bracing for a moderate upward revision in FOMC members' expectations. The outcome of the survey should have good predictive power, as it relates to interest rate developments over the next few months, and thus there is little potential for changes in opinion until the actual decision is made.

If there is any potential for surprise in the survey, it relates to the overall rate hikes still ahead and is likely to be on the upside. The cooling of the labor market, a declared goal of the Fed, has so far succeeded only to a minor degree. Inflation has been falling since the summer, but pretty much exclusively due to lower contributions from energy prices. In October, core inflation did show a slowdown, but this will hardly be enough for the Fed. On the first day of the two-day FOMC meeting, i.e. before the outcome is announced, inflation data for November will be released, but it is unclear whether this will still feed into the survey.

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