Growing hopes that the eurozone's red-hot inflation is nearing its peak could prompt European Central Bank policymakers to opt for a smaller rate hike on Thursday, observers said.
Following two consecutive interest rate hikes of 75 basis points, markets are on tenterhooks to see whether the ECB will keep up the aggressive pace or downshift to 50 basis points as the region braces for a winter recession.
This week's meeting of the ECB's 25-member governing council in Frankfurt will be the final one of 2022, a year that will be remembered for unprecedented consumer price shocks as Russia's war in Ukraine sent food and energy costs soaring.
Like other central banks, the ECB has fought back with a series of interest rate rises -- walking a tightrope between raising borrowing costs enough to tame inflation, without dampening demand so much it triggers a deep economic downturn.
ECB governors may take heart from November's eurozone inflation data, which showed prices slowing for the first time in 17 months on the back of cooling energy costs.
Inflation remains eye-wateringly high, however, at 10 percent -- five times the ECB's target -- and president Christine Lagarde has repeatedly said further rate hikes are needed.
But the rare bit of good news has bolstered hopes that price pressures are finally easing in the 19-nation in currency club.
"I would be reasonably confident in saying that it is likely we are close to peak inflation," the ECB's chief economist Philip Lane said last week.
The early Christmas present could "take away some of the urgency to continue with jumbo rate hikes," said ING bank economist Carsten Brzeski, even if a 75-basis-point hike is "still on the table".
Andrew Kenningham, chief Europe economist at Capital Economics, said he expected the ECB "to slow the pace to 50 basis points".
Observers may look across the Atlantic for clues on Wednesday, when the US Federal Reserve is set to announce its latest monetary policy decisions.
The Fed, which began hiking earlier and faster than the ECB, has signalled it could scale back the pace of its rate increases.
- Recession fears -
The ECB's rate decision will be guided by the latest economic forecasts due to be unveiled on Thursday.
Analysts expect them to show that inflation will remain well above the two-percent target in 2023 before falling back in 2024 and 2025.
The eurozone economy is seen shrinking in the final quarter of 2022 and the first months of 2023, meeting the technical definition of a recession.
Berenberg Bank economist Holger Schmieding said he expected "a significant winter recession for the eurozone as consumers and businesses hold back".
But with governments rolling out massive support packages and gas storage levels above average for this time of the year, "the region is better prepared for the cold season than expected", he added.
Schmieding urged the ECB not to "overdo its response to inflation", warning that aggressive rate hikes would make the recession "even more painful".
- Bloated balance sheet -
As part of its monetary policy tightening, the ECB will on Thursday outline the next steps in its efforts to slim down the bank's massive balance sheet.
It has already made changes to the terms of an ultra-cheap bank loan scheme, aimed at keeping credit flowing during the pandemic, in a bid to incentivise early repayment of the so-called TLTRO loans.
The move appears to be paying off, with eurozone lenders handing back nearly 750 billion euros ($790 billion) in TLTRO cash since October.
Analysts are also eager to hear how and when the ECB plans to start shrinking its five-trillion-euro bond portfolio, after years of hoovering up government and corporate debt.
The issue will be discussed at this week's meeting, Lagarde has said.
The ECB has already indicated that the process of "quantitative tightening" -- letting the bonds mature or actively selling them -- would be gradual and predictable to avoid spooking financial markets.
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