A Slowdown In The Pace Of Rate Increases By The ECB May Be Coming

The European Central Bank meets next Thursday and looks set to slow the pace of aggressive interest rate hikes as inflationary pressures finally show signs of abating.

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Read naxt: FX: Movement Of Major Currency Pairs This Week| FXMAG.COM

Forecast

The ECB has already raised its main lending rate by 2% since July in three separate increases.

The ECB is due to meet again on December 15 amid expectations that rate will be increased again.

Comments from ECB officials this week saying inflation was probably close to its peak have bolstered expectations that the central bank is likely to slow its pace of interest-rate increases to half a point from 75 basis points previously, on December 15.

Markets anticipate a 50 basis point, or half point, rate hike after two straight increases of 75 basis points each, slowing the pace of tightening.

Recent comments from ECB officials wouldn’t lead one to believe that a pace decrease is in sight but market participants are still leaning towards a smaller rise, with 55bps priced in, after 75bps hikes in September and October. The dovish emphasis came from the October meeting minutes which highlighted the progress that had been made from removing the accommodative policies. In its October decision, the ECB said "substantial progress" had been made in withdrawing policy accommodation and the lags involved in the transmission of the earlier tightening measures.

But the ECB is likely to stay hawkish and investors will also look for clues on where the deposit rate is going.

Deutsche Bank economists see the terminal rate at 3%, with risks skewed to the upside.

The ECB meeting coming after the Fed, so some may question whether the Fed’s decision will have an impact at all.

Data

A sharp slowdown in inflation in the US in October and the eurozone in November has encouraged investors to believe the worst may be over in terms of price pressures, causing global yields to drop sharply in recent weeks.

Germany's 10-year bond yield, seen as the benchmark for the eurozone, rose one basis point to 1.8%, while the Irish and French 10-year yields traded at around 2.3%.

Many investors say the sharp drop in eurozone yields has gone too far, given that annual inflation is still running at 10% and that the ECB is set to raise rates to at least 2% next week. Eurostat said area inflation rose 10% in the year to November, which is a decline on October's 10.6% and lower than the consensus expectation amongst economists for a reading of 10.4%.

Excluding food, fuel, alcohol and tobacco, inflation is at 5% and pipeline pressures remain abundant.

Closely-watched business activity data points to a mild recession and latest forecasts should show how the ECB views the coming slowdown.

In September, it forecast 0.9% eurozone growth in 2023, a significant downgrade from its June prediction.

Recent reports have shown that employment rose slightly and the GDP Y/Y and GDP Q/Q readings turned out to be higher than expected. GDP Y/Y increased to 2.3% against the expected 2.1%, while GDP Q/Q increased by 0.1% to 0.3%. A positive GDP reading may influence the ECB's decision.

Retail sales in Europe continue to fall. It came down to -2.7% in October, which is far worse than the expected.

EUR/USD

Euro exchange rates would be set to benefit if the European Central Bank (ECB) defies expectations next week by hiking 75 basis points, an outcome some economists say is likely.

A 50bp move would therefore be a neutral outcome for the Euro to Dollar exchange rate.

Source: investing.com, ecb.europe.eu