La Française: Inflation uncertainty vs growth uncertainty

December 13, 2022

By François Rimeu, Senior Strategist, La Française AM

At the December meeting, we expect the European Central Bank (ECB) to slow down the pace of interest rate hikes with a 50 basis points (bps) increase despite some debate over a 50 or 75 pbs hike. The central bank will update its macro-economic projections, including inflation projections for 2025, published for the first time.

Please find below what we expect:

• We expect the ECB to increase its interest rates by 50 bps, bringing the deposit rate to 2.0%.
• We expect ECB President Christine Lagarde to reiterate a meeting-by-meeting approach. She will signal further rate hikes beyond December without providing guidance on the level of the terminal rate.
• We expect Mrs. Lagarde to be very cautious about the downside surprise on the November headline inflation print, considering that at the core level, consumer prices were unchanged at 5.0%.
• As widely expected, we expect the Governing Council (GC) to announce the key principles regarding the reduction of their bond holdings related to the asset purchase program (APP). Quantitative tightening (QT) could in our opinion start in March 2023. QT will most probably be a gradual and passive process with partial reinvestment of the maturing bonds and not involve the active selling of bonds. The GC will reserve the right to adjust the timing and pace of QT over time.
• We expect the ECB to pursue reinvestments under its pandemic emergency purchase programme (PEPP) “until at least the end of 2024” and to apply flexibility to its reinvestments as the first line of defense against Eurozone fragmentation risk.
• We expect Mrs. Christine Lagarde to reiterate that fiscal policy support should be temporary and targeted at the most vulnerable households in order to avoid inflationary pressure.
• On the economic front, we expect the ECB’s inflation projections to be revised higher in 2022 (from 8.1% to 8.5%) and 2023 (from 5.5% to 6.1%). Inflation would then be converging to the 2% target at the end of the forecast horizon (2024 at 2.3% and 2025 at 2.0%). On growth, projections will indicate slightly higher growth in 2022 (from 3.1% to 3.2%) but lower GDP in 2023 (from 0.9% to 0.3%) and 2024 (from 1.9% to 1.5%). We expect the new 2025 projection will show a trend of 1.5%.

In summary, we expect the ECB to confirm its intention to pursue interest rate hikes in 2023 but at a slower pace, as the central bank will move in restrictive territory. We do not expect this meeting to push interest rates higher although we expect the ECB to maintain its hawkish communication. We believe the Fed’s committee and the US inflation report could have a bigger impact on financial markets.