Markets are prepared for another 50 bp hike from both the ECB and BoE, as central banks move their focus from headline inflation rates to underlying inflation pressures and wage growth. A 75-basis point hike from Lagarde cannot be ruled out, but the hawks will likely be placated with a commitment to end the re-investment of maturing assets next year. The start of QT may in fact be more of a problem for governments that are facing rising refinancing costs than the rise in official rates, and the ECB will have to keep a close eye on spreads next year.
Eurozone HICP may have dropped back in November, but at 10.0% it remains far above the ECB’s 2% target. At the same time, the deceleration in the headline was largely due to lower energy prices, and core inflation held steady at 5.0%. It is not surprising then that council members see the need for additional rate hikes to take out the remaining stimulus. Indeed, ECB head Lagarde has already suggested that rates will have to turn restrictive to ensure that inflation falls back to target. Chief economist Lane, hardly one of the hawks, has switched focus to wage growth and underlying inflation pressures.
Lane admitted recently that the ECB does now “think there will be a second round of inflation”. He added that “many sectors need to raise their prices because their costs have gone up. Many workers also have so far suffered a big reduction in their living standards, but we expect them to receive bigger pay increases next year and in 2024 and 2025 also. These bigger pay increases will support expenditure and will also raise prices. That is why it will take some time to return to our 2% target. So, the second round effects will drive inflation next year and in 2024.”
Rates will need to go up further then and judging by comments from central bank officials the debate will focus on 50 basis points versus another 75 basis points. Much will depend on the updated set of forecasts, which are likely to bring further upward revisions to the inflation projections for next year and beyond. At the same time, growth this year held up better than feared, but the new projections will factor in a shallow recession over the winter now.
Given that the ECB’s latest survey of consumer inflation expectations flagged upside risks, Lagarde remains under pressure to confirm the ECB’s commitment to bring inflation down.
A 75-basis point move remains a risk, though and an overly hawkish signal on QT could push out spreads once again. Lane suggested that QT ideally runs in
the background and supports the ECB’s policy objective, but national central bank heads will prepare for the potential fallout and the risk of financial turmoil. Ideally, the central bank would start to shorten its balance sheet at a time when growth is strong and governments are able to scale back expenditure, but the Ukraine war has thrown a spanner in the works. Governments are forced to raise spending to ease the pain of rising energy costs, and the need to finance elevated budget deficits means that government bond supply will be higher than initially anticipated. Refinancing costs will rise even more if the ECB scales back its asset holdings, and officials will have to keep a close eye on spreads next year.
GER40
GER40 stands at 11-month resistance at the 14,600-15,000 area, struggling to break it for a 5th consecutive week. 14,600 also represents the 61.8% retracement level since the November 2021 drift, indicating that the GER40 response at that level could be crucial for the Q1 outlook next year. A move lower could suggest bearish reversal potential if prices close the week below 14,150. As the daily chart highlights, the extended wicks that are indicative of firm levels of Support and resistance and the 14000 psychological level are assisting in capping the downside move. However, a golden cross has been seen this week, which if combined with further buying pressure and a break of 14,600 could see DAX prices retesting 2021 highs.
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Andria Pichidi
Market Analyst
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