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.