WOOD Flash – Europe macro: ECB’s stance to stay hawkish for a long time, but attention is shifting to liquidity

We have moved our macro forecasts back to a single core scenario, instead of two plausible outlooks, as we feel that we now have enough evidence to signal the strong likelihood of a moderate 2023E recession in the Eurozone. The good news is that front-loaded fiscal support to partially offset the energy shock, positive bank lending growth, and a steady focus on deployment of the green and digital transition limit the downside to GDP in the coming quarters. The downside, however, is that the aggressive Fed tightening has worsened the global growth outlook and the energy crunch risks may not be acute in the near term, but could persist going into 2024E. Our assessment is that average inflation will moderate from 8.6% in 2022E to 7.7% in 2023E, and further still, to 4.2%, in 2024E. Achieving the ECB’s target remains out of reach in most realistic scenarios. Given this background and the latest comments from the ECB’s Governing Council, we forecast the peak for the deposit rate facility at 2.50% early next year, and a shift of focus to liquidity and balance sheet management starting from the December meeting. Our fair value model signals that core Eurozone bond yields continue to have ample scope for further upside.