"ECB Following Fed's Lead, Expected to Shift to Dovish Stance"

ECB Executes 'Big Step'... Hawkish Content
Risks to Economic and Financial Stability Exist
Dovish Shift Expected

Christine Lagarde, President of the European Central Bank (ECB)
[Photo by Reuters]

[Asia Economy Reporter Yoonju Hwang] At the December monetary policy meeting, the European Central Bank (ECB), which took a hawkish stance similar to the U.S. Federal Reserve (Fed), is expected to preemptively shift to a dovish stance if concerns about domestic and external economic recession and financial stability arise.

On the 17th, Yoonjung Park, a researcher at NH Investment & Securities, stated, "We expect the terminal rate to reach 2.75% in the first quarter of 2023 and the formation of a peak in long-term Bund (German government bond) yields." Long-term yields are highly correlated with the economy. The formation of a peak in long-term yields implies that it will be difficult to maintain a tightening (rate hike) stance amid the possibility of an economic recession.

The previous day, the ECB raised its key interest rate by 50 basis points (1bp = 0.01 percentage points) at the December meeting. It also announced that from March 2023, it will conduct quantitative tightening (QT) by reducing its asset purchase program (APP) by an average of 15 billion euros per month in government bond purchases.

The market evaluated the ECB's monetary policy as "hawkish (tightening)." Researcher Park explained, "Although the rate hike size was reduced to 50bp, the statement provided guidance that a substantial rate increase is necessary to maintain tight monetary stability." She added, "This is quite hawkish compared to earlier this year when the ECB avoided answering the need for a key rate above the neutral rate throughout the year."

The inflation forecast was also significantly revised upward. Core inflation was raised from 3.5% to 4.2% for 2023, and adjusted from 2.4% to 2.8% for 2024.

While acknowledging the possibility of an economic recession, the ECB expects it to be mild. Real GDP growth rates were projected at 3.4% for 2022 and 0.5% for 2023. These figures are optimistic compared to the downside scenario from September (2.8% for 2022 and -0.9% for 2023).

Researcher Park pointed out, "For the 4.2% core inflation in 2023 to be justified, demand-side inflationary pressures similar to this year must be confirmed, but the European Commission's service sector survey shows that future demand expectations are rapidly shrinking." She diagnosed that the inflation forecast is somewhat high relative to growth conditions.

She criticized, "The bond market also doubts the possibility of a soft landing in the U.S., where economic resilience is stronger than in the Eurozone." She added, "It will be difficult for the ECB's soft landing and hawkish strategy to gain trust." In fact, during the ECB meeting, shocks to U.S. retail sales and industrial production in November were confirmed, raising concerns about strong downward pressure on Eurozone export demand due to U.S. demand contraction. She concluded, "Considering economic and financial stability risks, a dovish shift will eventually occur."

This content was produced with the assistance of AI translation services.