(Bloomberg) -- After ramping up borrowing costs for more than a year, all eyes will now be on how forcefully the European Central Bank pushes back against bets on interest-rate cuts.

The extent of its resistance will hinge on fresh projections for the euro-zone economy — arriving on the heels of a surprisingly steep slump in inflation. That outlook may also help the ECB decide whether to hasten its exit from quantitative easing by phasing out reinvestments under the €1.7 trillion ($1.8 trillion) pandemic-era PEPP initiative.

Economists polled by Bloomberg all see the deposit rate being left at 4% on Thursday. But with price growth already nearing 2% and the region facing a first recession since Covid, the focus is now firmly on when officials will begin unwinding their unprecedented monetary tightening, especially after the Federal Reserve’s pivot on the matter on Wednesday. Markets see a first ECB cut as early as the spring.

That’s a lot sooner than policymakers would like. President Christine Lagarde herself has said no reduction should be expected “in the next couple of quarters,” though the future of PEPP will be discussed “in the not-too-distant future.” She’ll brief reporters in Frankfurt half an hour after the ECB’s 2:15 p.m. announcement.

“I think the ECB are going to do something similar” to what the Fed did, Jason Davis, a rates portfolio manager at JPMorgan Asset Management told Bloomberg Television. “They won’t be too explicit in endorsing the cuts for next year, but what they will have to appreciate is the change in inflation.”

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Interest Rates

Economists in a separate Bloomberg survey predict June will see the first of three quarter-point cuts next year — taking the deposit rate to 3.25%. They anticipate another three steps of that magnitude in 2025.

Traders are more dovish — wagering on that volume of easing coming in 2024 alone and kicking off as soon as March. 

On Thursday morning, markets priced in 157 basis points of ECB monetary easing next year, the most in the current cycle. That means six quarter-point cuts are fully priced in and there’s a 30% chance of a seventh move.

Lagarde is unlikely to validate these views, even after inflation sank to 2.4% in November — the lowest since mid-2021. Instead, she’ll probably explain that price pressures are set to tick up again, rendering such discussions premature. 

The overall picture may only become clear when the full extent of wage deals and governments’ fiscal plans emerge after the first quarter.

What Bloomberg Economics Says...

“Given the risks around the inflation outlook, the ECB is probably unhappy with interest-rate swaps pricing in a rate cut in March. Lagarde may make that clear in the press conference. Bloomberg Economics’ view remains that the first cut will come in June and the risks are skewed toward earlier action.”

—David Powell, senior euro-area economist. Click here for full preview 

The most economists and investors can maybe expect is a signal that — barring any economic shocks — further rate hikes are off the table.

Economic Projections

Updated quarterly projections for growth and inflation will shape any guidance on the policy path, with analysts polled by Bloomberg expecting the new outlook to have a stronger-than-usual impact on ECB messaging.

Following recent hard data, a previous forecast for consumer prices to advance 3.2% in 2024 will almost certainly need to be trimmed — as will the call for gross domestic product to increase 1%.

In September, the ECB saw inflation reaching its 2% goal in the second half of 2025. But even if it looks able to hit that target more quickly, it will be wary of declaring victory ahead of time. 

Executive Board member Isabel Schnabel summed the situation up, describing progress on inflation as “remarkable” while urging officials to remain vigilant.

PEPP

The idea of halting reinvestments before the current end-2024 deadline has been kicked around by the Governing Council’s more hawkish members for months. Lagarde putting the issue on the agenda suggests support is building in the dovish camp, too.

Bringing forward the withdrawal from PEPP would help avoid market confusion down the line: Without a change in the timetable, the tightening step would almost certainly come in the midst of a rate-cutting cycle. 

Two-thirds of respondents in a Bloomberg survey predict the ECB will accelerate its schedule. Of those, most see roll-offs starting in the second quarter.

“On the face of it, it feels like bringing forward the end of reinvestments is quite a hawkish signal,” Katharine Neiss, chief European economist at PGIM, said on Bloomberg TV. “Ironically, the market is going to take it as a dovish signal, because by announcing something on PEPP now, it effectively gives them the nimbleness, the ability to bring forward cuts early next year if they deem that to be necessary for the euro-area economy.”

Economists at Goldman Sachs, Barclays and Societe Generale are among those arguing that the ECB may employ a strategy similar to the one it used to phase out an older quantitative-easing program. 

That would entail rolling over only about half the proceeds from bonds maturing between March and June, before discontinuing the practice from July.

Such a timeline would ensure that one of PEPP’s most important features — flexible reinvestments that allow the ECB to soothe stress in parts of the euro-zone bond market — stays in place during the typical early-year rush by governments to issue debt.

Other Issues

Lagarde is likely to strengthen her call for governments to agree on new European fiscal rules after complaining in the past that she’s “uncomfortable” with the lack of progress. A budget impasse in Germany, the region’s largest economy, is making it harder still to predict how much public spending to expect.

She may also be quizzed on her views about a European Union proposal to tax profits generated by frozen Russian central-bank assets to help rebuild Ukraine. Lagarde has warned Brussels in the past that such a move could threaten financial stability and the liquidity of the common currency.

--With assistance from Harumi Ichikura, Joel Rinneby, Anna Edwards, Tom Mackenzie, Aline Oyamada and Francine Lacqua.

(Updates with PGIM quote in PEPP section)

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