Investment Institute

How Far to Diverge

  • 09 May 2023 (5 min read)

  • The Fed has probably hit peak policy rate, we expect two more 25 bps hikes from the ECB
  • Euro area core inflation may be stickier than in the US, but some “policy patience” may be warranted there

Last week’s communication from the Fed and the ECB points to a divergence in the months ahead. We think the “soft hiking bias” the Fed retains is largely driven by a so far unsuccessful attempt to stop the market from pricing future rate cuts even more aggressively. The mention of an “additional firming” of monetary policy in the US no longer is the “statement of intent” it was last time, and there was enough in Jay Powell’s comments to hint at a pause. On the other side of the Atlantic, Christine Lagarde’s mention in the press conference that the ECB has “more ground to cover” told us that they are not “done”. Our baseline is that the Fed has indeed reached the peak of its monetary tightening in this cycle, while we expect from the ECB two more 25-bps hikes to a terminal rate of 3.75%, with a significant risk it goes to 4%. In our own forecasts core inflation in the Euro area will not decelerate markedly before the end of the summer, and this is clearly crucial in the ECB’s current reaction function.

Yet, from a “normative” point of view – what we think the ECB should do, rather than predicting what it will do – we are worried. The ECB is taking the deterioration in credit origination seriously – this was key in their decision to opt for 25 bps rather than 50 last week – but seems yet unconvinced this will have a serious enough impact on the real economy to take core inflation durably down. The saving buffers accumulated by the private sector since the pandemic may delay the transmission of tougher credit conditions to spending decisions, but this protection cannot be eternal. The US remains the epicentre of a “banking turmoil” which keeps on re-appearing, but the decline in credit demand from the private sector in the Euro area is a concerning signal. The shape of the yield curve in the Euro area has become very similar to the US one. The bond market may be signalling that if the US gets into recession, it will be difficult for the Euro area to avoid one. This brings a clear limit to the scope of policy divergence beyond the next few months. Sticky inflation in the Euro area may reflect a slower reaction to macro conditions than in the US, not necessarily a difference in the ultimate sensitivity to the cycle.

Related Articles


What will it take?


Letter from China


Saved by Supply


    This website is published by AXA Investment Managers Asia (Singapore) Ltd. (Registration No. 199001714W) for general circulation and informational purposes only. It does not constitute investment research or financial analysis relating to transactions in financial instruments, nor does it constitute on the part of AXA Investment Managers or its affiliated companies an offer to buy or sell any investments, products or services, and should not be considered as solicitation or investment, legal or tax advice, a recommendation for an investment strategy or a personalized recommendation to buy or sell securities. It has been prepared without taking into account the specific personal circumstances, investment objectives, financial situation or particular needs of any particular person and may be subject to change without notice. Please consult your financial or other professional advisers before making any investment decision.

    Due to its simplification, this publication is partial and opinions, estimates and forecasts herein are subjective and subject to change without notice. There is no guarantee forecasts made will come to pass. Data, figures, declarations, analysis, predictions and other information in this publication is provided based on our state of knowledge at the time of creation of this publication. Whilst every care is taken, no representation or warranty (including liability towards third parties), express or implied, is made as to the accuracy, reliability or completeness of the information contained herein. Reliance upon information in this material is at the sole discretion of the recipient. This material does not contain sufficient information to support an investment decision.

    All investment involves risk, including the loss of capital. The value of investments and the income from them can fluctuate and investors may not get back the amount originally invested. Past performance is not necessarily indicative of future performance.

    Some of the Services and/or products may not be available for offer to retail investors.

    This publication has not been reviewed by the Monetary Authority of Singapore.