The European Central Bank and Bank of England are expected on Thursday to match the Federal Reserve by raising interest rates 50 basis points. All are doing so to battle inflation that has at various times this year hit multi-decade highs. But the scenarios they face are all slightly different.
Here’s what to expect, and why, from the European monetary guardians.
Bank of England decision
First up, at 12 noon GMT (7 a.m. Eastern), the Bank of England’s Monetary Policy Committee is expected to take Bank Rate, as it is known, from 3% to 3.5%.
Trajectory. A 50 basis point hike marks a deceleration in tightening. The BoE raised rates by 75 basis points after its early November meeting. Bank Rate was just 0.25% a year ago. Markets currently are pricing in that it is most likely the next MPC meeting in February will deliver a 25 basis point hike.
Inflation. Like its peers, the BoE’s spike in borrowing costs is mainly designed to combat surging consumer prices. U.K. inflation hit a 41-year high of 11.1% in October as energy and food costs soared. There was better news on this front on Wednesday, when CPI for November was shown to have dipped to 10.7% as petrol (gas) prices eased.
Economy. Data released on Monday showed the U.K economy shrank by 0.3% in the three months to October, and the country is likely to be in recession for most of 2023, according to the BoE. Inflation itself is taking a toll, with wages on average not keeping pace and the subsequent cost of living crisis crimping households’ discretionary spending.
The central bank’s tighter monetary policy is also having a notable impact. The U.K. economy is particularly sensitive to interest rate changes through the housing market. Home prices relative to incomes are high, and a large proportion of borrowers have floating rate mortgages, meaning higher Bank of England interest-rates raise monthly payments sharply. Halifax, the lender, last week said U.K. house prices fell 2.3% between October and November, the third consecutive decline and the fastest retreat since the 2008 financial crisis.
Watch out for… Traders will be keen to see how much the MPC was split on the decision, for it may provide a guide to the majority outcome in the next meetings. The rates and currency research team at Bank of America reckon there could be a three-way split, with two members voting for no change, five for 50 basis points and two for a 75 basis point hike.
There will be no press conference this month, but investors will scan the minutes for any comments regarding the expected peak, or “terminal rate” for this cycle. Last month BoE Governor Andrew Bailey warned the market was being too aggressive in its expectations for rate rises in 2023. Then the market’s terminal rate was 4.75%. It’s now barely lower at 4.6%.
“We think the minutes could contain overt guidance again to markets that Bank Rate will not need to rise all the way to 4.5%,” said Samuel Tombs, chief U.K. economist at Pantheon Economics.
“As a reminder, the key line from November’s minutes was that a majority of members thought that ‘further increases in Bank Rate may be required for a sustainable return of inflation to target, albeit to a peak lower than priced into financial markets.’ True, investors expected Bank Rate to peak just about 5.0% in the run-up to November’s meeting. But overall financial conditions are just as tight as before the MPC’s last meeting,” Tombs added.
The European Central Bank will deliver its policy decision at 2:15 p.m. CET (8:15 a.m. Eastern) and President Christine Lagarde will start a press conference at 2:45 p.m. CET.
Trajectory. The ECB has a number of borrowing costs but expectations are that the deposit rate will be raised by 50 basis points to 2%. This also represents a slower pace of tightening after the 75 basis point hike in early November. The deposit rate was negative for several years until the summer.
The market is not fully sure it can rule out a 75 basis point move this week, but strategists at BNP Paribas said: “The Governing Council had communicated a bias already at the 27 October meeting for a reduced pace of hikes – data dependent – from December, in our view. Although not a done deal, the uncertainty around the size of the December move has diminished in recent weeks, we think.”
Inflation. Eurozone inflation was 10.6% in October, a record high, according to Eurostat. Energy inflation accounted for 4.44% percentage points, followed by food, alcohol and tobacco at 2.74 percentage points. A year ago inflation was 4.1%. The November inflation report is due for release on Friday.
Economy. The eurozone economy grew 0.3% in the third quarter of 2022, but the ECB, in its most recent forecast published in September, said it thought GDP would grow just 0.9% during the whole of 2023 from an estimated 3.1% this year as consumers and companies are impacted by high energy costs.
“Economic growth in all euro area countries is expected to be reduced as a result of the extremely high gas prices, which will render some activities unprofitable in the most gas-intensive sectors, leading to production being suspended in some cases,” said the ECB.
“Overall, real GDP is expected to contract by 0.1% in the last quarter of 2022 and remain flat in the first quarter of 2023,” the ECB added.
Watch out for….Any update to the ECB’s growth forecasts. Analysts at Berenberg reckons that its new set of quarterly projections may show the central bank becoming “more gloomy again for 2023, with less growth and more inflation than it predicted in September”.
“We expect the ECB to admit that real GDP will probably decline in Q4 2022 and Q1 2023, taking the ECB’s call for 2023 as a whole from 0.9% to c0.5% growth. If so, that would still be well above our call for a 0.5% contraction in Eurozone GDP next year,” Berenberg wrote in a note.
The other main issue to keep an eye on will be what the ECB says about quantitative tightening, or the tapering of asset purchases. “We expect the tapering in APP [asset purchase programmes] reinvestments to start at the end of Q1 at ~€20bn/month and to converge to €28bn/month (a complete stop) later in the year, but this is where a hawkish surprise is most likely to come from – earlier start and faster convergence,” said Davide Oneglia at TS Lombard.
Forex markets. Most analysts are wary of betting on further gains for the euro
unless there are particularly hawkish surprises from the ECB and BoE. Against the dollar, the pound is up more than 5% in just the past month and the euro has added more than 3% after traders bet on a relatively less hawkish Federal Reserve.
“Positioning across FX has significantly reduced in recent weeks, where short EUR positions have been completely squeezed and longs have started to build,” noted BNP Paribas.
Bank of America said: “With our base case for the Bank Rate path in line with market expectations, we expect the upcoming BoE meeting to have a minimal impact on GBP.”