Nordea looks for 75bp hikeDefying market expectationsWould support EUR/USDDanske says 50bp likely but with hawkish twistEUR reaction also depends on Fed and U.S. CPI

Image © European Central Bank

Euro exchange rates would be set to benefit if the European Central Bank (ECB) defies expectations next week by hiking 75 basis points, an outcome some economists say is likely.

"There is more uncertainty than usual around the ECB's December monetary policy decision and also more issues to decide. We think the ECB will surprise hawkishly by hiking by 75bp for the third time in a row," says economist Jan von Gerich at Nordea Bank.

The consensus is however leaning towards a 50bp rate hike, according to money market pricing, as the ECB looks to slow the pace from October's outsized 75bp jump.

A 50bp move would therefore be a neutral outcome for the Euro to Dollar exchange rate (EUR/USD).

Bets for a 50bp hike were egged on by the ECB's communication issued at the October meeting where it said it may slow down the pace of its interest rate increases going forward.

In its October decision, the ECB said "substantial progress" had been made in withdrawing policy accommodation and the lags involved in the transmission of the earlier tightening measures.

November inflation data meanwhile surprised to the downside, leading some economists and financial markets to lean towards a 50bp hike on the expectation the ECB will believe progress is being made.

Eurostat said area inflation rose 10% in the year to November, which is a decline on October's 10.6% and lower than the consensus expectation amongst economists for a reading of 10.4%.

"While we're far from out of the woods yet, it does look like the current economic environment could push the European Central Bank to a smaller 50bp hike next month," says Bert Colijn, Senior Economist for the Eurozone at ING Bank.

"We disagree," says von Gerich. "Several Governing Council members have emphasised the need to raise rates to restrictive territory to rein in inflation, likely meaning levels clearly above 2%."

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Isabel Schnabel, Member of the ECB's Governing Council, is a notable 'hawk' and said on November 24, "incoming data so far suggest that the room for slowing down the pace of interest rate adjustments remains limited, even as we are approaching estimates of the 'neutral' rate."

von Gerich says one inflation number is unlikely to soothe the ECB's inflation concerns, especially as core inflation stayed put at 5% year-on-year.

He also points out that market interest rates have fallen back sharply over the past month, which is at odds with the ECB's objective of trying to remove accommodation and tighten financing conditions.

If the Nordea position is correct and the ECB does go with a 75bp hike, it would prove a hawkish outcome that would lift Eurozone yields and likely offer the Euro support.

However, analysts at Danske Bank say there are other avenues for the ECB to strike a 'hawkish' tone that ultimately supports the single currency.

"We expect the ECB to deliver a 50bp rate hike with a hawkish twist," says Piet Haines Christiansen, Chief Strategist for ECB and Fixed Income at Danske Bank.

"Ahead of the October meeting, when all GC members were zooming in on a 75bp rate hike, we did not hear much from the doves, but that has now changed, with notably Lane and Panetta arguing for a moderation in the hiking cycle pace," he explains.

Additional data showed Eurozone wages are also picking up, which is an inflationary development, and the 'hawks' on the GC remain vocal.

This requires a compromise to be sought between the two factions.

"We expect the doves to focus on slowing the hiking pace to 50bp, with an agreement to continue to hike rates for as long as needed on a data dependent and meeting-by-meeting approach," says Christiansen.

"This will be palatable to the hawks, as we expect them to get a more hawkish calibration on the end to the APP reinvestments," he adds.

On the face of it, such an outcome would be supportive of the Euro.

But Danske Bank's chief currency strategist, Jens Nærvig Pedersen, warns the coming week will be a busy one for foreign exchange markets which ultimately complicates the Euro's reaction to the ECB's 'hawkish' decision.

"For EUR/USD, the ECB meeting will conclude a busy week that also includes U.S. CPI and the FOMC meeting. Overall, we do not expect a 'hawkish 50bp hike' will leave a big impact on EUR/USD, but it depends on the momentum heading into the meeting," he says.

Pedersen looks for the market to "feed off a hawkish ECB" in the event the all-important U.S. CPI inflation data out Tuesday drops again and if the Federal Reserve comes across as dovish on Wednesday.

These two outcomes would potentially send EUR/USD to new highs.

"Vice versa, higher U.S. CPI inflation may turn around momentum in EUR/USD, send it back down and leave the ECB meeting less relevant," says Pedersen.

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