LONDON (Reuters) - The European Central Bank meets next Thursday and looks set to slow the pace of aggressive interest rate hikes as inflationary pressures finally show signs of abating.
It has raised rates by a total 200 basis points (bps) since July, its fastest pace on record, to contain red hot inflation.
A slowdown in the pace of rate increases may be coming, but the ECB is far from done and markets want to get a sense of where the key 1.5% deposit rate will end up.
"They (policymakers) will keep sounding hawkish and aggressive as they want inflation expectations to remain anchored," said Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management.
Here are five key questions on the radar for markets.
1/ What will the ECB do on Thursday?
Markets anticipate a 50 basis point rate hike after two straight 75 bps increases, slowing the pace of tightening.
But the ECB is likely to stay hawkish and investors will also look for clues on where the deposit rate is going.
Money market pricing suggests rates will peak in June 2023 at around 2.7%, but some reckon the rate will end up higher because underlying price pressures remain strong and expansionary fiscal policy may boost inflation.
Deutsche Bank economists see the terminal rate at 3%, with risks skewed to the upside.
"We must accept that the future rate path is a discovery process for markets and central banks," said Francis Yared, global head of rates research at Deutsche Bank.
Will the ECB slow down? https://www.reuters.com/graphics/EUROZONE-MARKETS/ECB/mopaknxbjpa/chart.png
2/ Is euro zone inflation peaking?
Headline inflation slowed in November for the first time in 1-1/2 years, to 10%, raising hopes that sky-high price growth has passed.
Yet inflation remains above its 2% target. ECB President Christine Lagarde will likely be careful about calling a peak after last year's "big mistake" of insisting surging prices were "transitory," said Pictet's Ducrozet.
Excluding food, fuel, alcohol and tobacco, inflation is at 5% and pipeline pressures remain abundant. ECB Chief Economist Philip Lane reckons wages would be a "primary driver" of price inflation even after energy price shocks fade.
Euro zone inflation off record highs https://www.reuters.com/graphics/EUROZONE-MARKETS/ECB/myvmoommdvr/chart.png
3/ Will the ECB discuss QT?
Probably. How to run down the bonds held on its balance sheet in what is known as quantitative tightening (QT) is a key part of the ECB's policy debate.
The ECB may offer some guidance on how QT will apply to its 3.3 trillion euro Asset Purchase Programme and is likely to be pressed for details.
"A start in February with partial reinvestment similar to what the Fed does is most likely," said Patrick Saner, head of macro strategy at Swiss Re.
Active bond sales were expected to be ruled out for now.
QT is coming https://tmsnrt.rs/3VIgGN2
4/ Does the ECB think a recession will be shallow?
Closely-watched business activity data points to a mild recession and latest forecasts should show how the ECB views the coming slowdown.
In September, it forecast 0.9% euro area growth in 2023, a significant downgrade from its June prediction.
UBS's chief European economist Reinhard Cluse expects the ECB to reduce its outlook to 0.5% growth for next year, with "the assessment that we are clearly slowing down and two quarters of negative growth might well occur, but a deep recession (is) unlikely to be their core scenario."
Global economic activity flashes red https://www.reuters.com/graphics/EUROZONE-MARKETS/ECB/movakkmnnva/chart.png
5/ ECB policymakers are divided over the outlook, what does that mean?
Lane and Isabel Schnabel, who lead the economic debate on the ECB board, have given contrasting views recently.
Lane believes record price growth will start to subside next year. Schnabel argues that the longer inflation is allowed to remain high, the greater the risk that it takes root.
Lagarde could be pressed on how she views the sparring between top officials. A compromise could be the outcome.
"With the doves being vocal again, we are looking into a period where hawks will not be the only ones trying to drive the monetary policy, which means that we will see bigger compromises," said Danske Bank chief analyst Piet Haines Christiansen.