ECB preview: a hawkish pause will satisfy hawks and doves

Economic data are screaming out loud stagflation for the Eurozone. The European Commission has cut the eurozone GDP for this year to 0.8% (prev. 1.1%) and 1.3% (prev. 1.6%) for 2024. Yet, inflation is poised to stay at 5.6% this year, while in 2024, it will drop to 2.9%, slightly higher than previously forecasted. In the meantime, confidence indicators are falling.

This week’s ECB monetary policy meeting will see the doves and the hawks fighting. Yet, it will come down to whether policymakers decide to tolerate negative growth surprises in Germany and the Netherlands. Indeed, the loudest hawks come from these countries, and the question is whether they will continue to support rate hikes while their economies are tumbling.

With the Federal Reserve having already delivered a successful hawkish pause, it might have arrived the time for the ECB to do the same. The biggest challenge will be for Lagarde to deliver a pause without sounding dovish. To do that, the central bank might need to look at its balance sheet and stop reinvestments under the Pandemic Emergency Purchase Program (PEPP).

Interest rate hikes are working

So far, the central bank has hiked by 425 basis points, bringing its deposit rate to 3.75%, just below market expectations of a 3.90% terminal rate. At this point, the ECB can claim that it has already done a lot and that rate hikes are slowly feeding through the economy, warranting a pause before deciding on another rate hike.