Through at least the early part of this year, the ECB is expected to go against the trend of most other major central banks. The BOE and Fed are expected to continue to slow the pace of rate hikes as inflation comes down, the economy comes under increased pressure, or (which is a likely scenario) both.
Meanwhile, the ECB is expected to continue to hike rates at a relatively aggressive pace. That rates might rise at the same ratio as the Fed’s did last year might be a bit of a stretch, though. The ECB has a different set of challenges, setting monetary policy for a series of countries with disparate fiscal policy. That might constrain the ECB’s final rate.
Where things are going
The ECB was the last of the major central banks to start hiking, which means there is more “headroom” for it to continue to tighten. It is still 200bps behind the Fed, for example. Given that the US is the only other economy that is comparable in size, and that both economies are each other’s largest trading partner, it’s an important comparison. Not just for the EURUSD.
The Euro was weakened substantially last year as the ECB hesitated to tighten and inflation moved above its peers. A large portion of that inflation was driven by an extraordinary event: the high prices in energy from the war in Ukraine. The hope is that winter will be less harsh than expected, leading to less demand for energy, and prices can come down. This would mean that inflation would start coming down, independent of the ECB’s policy.
There might be a problem
The main counter to this, naturally, is that no one can predict the weather. But there is another issue which isn’t garnering as much headlines: the “sticky-ness” of core inflation. “Sticky” is a growing concept in talking about inflation, referring to how CPI rates are not coming down as fast as hoped. They are “sticking” to the ceiling, as it were.
This was the case with the results from Spain’s prelim December CPI, released on Friday. Headline inflation came down, as expected; but core inflation remained elevated. At the end of the day, the ECB cares most about core rates, since that doesn’t take into account the volatility of things like energy. But, if energy prices remain high, eventually they seep through to the rest of the economy, making a challenging situation for the central bank. This could mean that interest rates might go up more than currently expected, and the normally dovish and conservative ECB might have to take measures similar to what the Fed has done last year, and substantially propel the Euro.
What data to look out for
Tomorrow we get the release of Germany’s latest inflation figures. The market can move around quite a bit as each German state reports, and sets up expectations for the main number. Overall, annual German December CPI is expected to decline sharply to 9.0% from 10.0% prior.
Annual German Harmonized inflation is expected to slow, but not as dramatically, dropping to 10.7% from 11.3% prior. Meanwhile, German unemployment for December is expected to remain steady at 5.6%, after adding 15K jobs, slightly less than the 17K added in November.