Cinquante rugissants

• We expect a “twin gear-change” in the pace of tightening from the Fed and the ECB, both opting for 50bps, but also quite a lot of hawkish rhetoric.
• The EU has few politically, financially, or institutionally appealing solutions to deal with the US IRA challenge.

It’s a big week for central banks. Market pricing and analysts’ expectations have converged around a “gear-change” in the speed of tightening, with the Fed and the ECB both opting for “50 bps only” hikes. We concur, even if the risk of another jumbo hike seems to us a bit higher in the Euro area than in the US. Yet we also expect this slowdown in the tightening pace to come with a big dollop of hawkish rhetoric to make it clear that the central banks are “not done yet”. This is especially a challenge for the Fed, given how markets have been quite stubborn in pricing in rate cuts quite quickly. However, the Fed can use quite effectively its “dot plot” to send clear messages. When it comes to the ECB, it’s less the trajectory for policy rates which is likely to be the “piece de resistance” but the first indications on Quantitative Tightening. We don’t expect much granularity this week on this, but we believe the ECB won’t want to “rock the boat” and will proceed carefully. Even a very gradual reduction in reinvestment can have a visible market impact though. We expect the supply of government bonds net of ECB operations to double next year relative to 2022.

Still, beyond these crucial monetary policy decisions, we also wanted to take a bit of perspective and explore further a theme which we find is going to rank more and more prominently in the macroeconomic debate: the rebound in US competitiveness, especially when compared with Europe. The Inflation Reduction Act is crystallising European fears of losing out to the US in the potential next industrial revolution: the green transition. We explore the options for an EU reaction, but none of them looks ideal from a political, institutional, or practical standpoint. Rather than focusing on a form of “retaliation”, the most productive approach would consist in delivering a boost to green transition investment by launching a “Next Generation EU” 2.0 programme, but we fail to perceive much enthusiasm across member states for such an additional effort.