ECB Governing Council member Ulo Kaasik indicated on Friday that investor expectations for additional rate increases are logical given current economic conditions, telling Aripaev that "it's understandable why the markets think that" the interest-rate hiking cycle will continue. The remarks come less than a day after the ECB delivered a widely anticipated quarter-point rate hike to 2.5%, the second increase since the start of the Middle East war. Kaasik said he "would certainly not consider the current level very high yet" and described it as "a level that should not yet perhaps directly tighten economic activity too much." Lithuanian counterpart Gediminas Simkus stressed that consumer-price growth is too strong, telling national broadcaster LRT that "inflation is too high both in the euro zone and in Lithuania." Simkus noted that Thursday's rate increase "isn't a decision aimed at the future" and emphasized the need for responsible communication about future decisions.
Barclays expects the European Central Bank to raise interest rates by another 25 basis points in December, as higher inflation projections and rising energy prices linked to the U.S.-Iran war strengthen the case for further monetary policy tightening, according to Reuters. Traders are now pricing in a 93.9% probability of another quarter-point rate increase from the ECB in December, based on LSEG data, with Goldman Sachs also forecasting a 25-basis-point increase in December, expecting the move to push interest rates into mildly restrictive territory. Barclays sees little likelihood of an additional move in October, instead expecting policymakers to wait until December when they will have a fresh set of economic forecasts and more data to assess the outlook for inflation and growth. The December policy meeting is increasingly emerging as a key point for investors assessing the ECB's next move, with energy prices remaining elevated and inflation projected to stay above target for longer.
Germany's 10-year yield rose six basis points to 3.50%, the highest since 2009, as reported by Bloomberg. The two-year rate climbed as much as 14 basis points to 3.21%, the highest in almost three years. Swaps are now fully pricing three more quarter-point increases by the middle of next year and a more than 70% chance of a move next month, according to Bloomberg. With oil back above $100 a barrel, investors are now pricing in three more hikes, as reported by Bloomberg. "Another hike before year-end is no longer a tail risk," said Patrick Ernst, a macro investment strategist at JPMorgan Private Bank, as reported by Bloomberg. "Policymakers made clear that an energy-led inflation risk is still very much in play," Ernst added.
The European Central Bank delivered its second interest rate increase of the year on Thursday (September 10), raising its benchmark deposit rate by 25 basis points to 2.50% as the Iran war fuelled inflation and renewed concerns over energy costs. Alongside the deposit rate increase, the ECB raised its main refinancing rate to 2.65% and marginal lending facility rate to 2.90%, with all changes taking effect on September 16. The move comes as renewed US-Iran attacks on military, shipping and energy assets since late August ended a month of relative calm, with oil prices climbing back above $100 a barrel, increasing the risk of higher costs spreading across the euro zone which relies on fuel imports. Euro area inflation rose to an estimated 3.3% in August from 2.9% in July, with energy prices 14.3% higher than a year earlier compared with a 10.3% increase in July, as reported by The Financial Express. The ECB stated that inflation was expected to stay above its 2% goal for some time, with the conflict in the Middle East continuing to generate inflation pressures. ECB President Christine Lagarde stressed the bank did not pre-commit to any future moves, telling a press conference that "We have not debated at all any kind of future path. Markets do what they have to do and we do what we have to do - which is to provide price stability."
The ECB's latest staff forecasts paint a concerning picture of prolonged inflationary pressures, with average headline inflation projected at 3% in 2026, 2.5% in 2027 and 2.1% in 2028, according to Business Standard. Inflation excluding energy and food is projected at 2.5% this year, 2.6% in 2027 and 2.3% in 2028. The central bank now sees inflation at 3.0% this year, 2.5% next year and 2.1% in 2028 - a 20-basis point rise in the 2027 forecast and a 10-basis point increase for the 2028 figure. The ECB also raised its growth forecasts for 2026 and 2027, now projecting expansion of 0.9% this year, 1.4% next year and 1.5% in 2028, citing an economy that had held up better than expected. The euro zone economy has been holding up better than anticipated despite higher fuel costs, competition from China and the impact of droughts, with bank lending even picking up pace in July, suggesting the ECB's June rate rise had not dented activity and giving policymakers scope to tighten further on Thursday. Barclays said the ECB's latest baseline outlook points to inflation returning to the central bank's 2% target only by late 2027, with ECB President Christine Lagarde explicitly acknowledging that gas prices could rise due to further supply disruptions or an unusually cold winter in combination with low storage levels across much of the region, saying "We believe inflation will be longer lasting than we had anticipated."
Investors anticipate a lot more action, spurred by a renewed advance in oil prices and an increase in the ECB's projections for inflation and economic expansion, as reported by NDTV. They're now fully pricing three more quarter-point hikes by the end of 2027, with a small probability of a fourth. Economists, in contrast, think Thursday's move may be the ECB's last for now, although a growing number see a risk that further tightening may be needed. Ed Hutchings, head of rates at Aviva Investors, said "The market is right in thinking more hikes will be coming," adding that he still sees value being created in European bonds, as reported by Bloomberg. "With two hikes already being delivered and more than a further two hikes priced, things may well have gone too far," Hutchings noted. Unlike the 2022 energy shock, this year's energy price shock is unlikely to spark a wage-price spiral, as demand conditions are not as conducive to higher inflation, according to Capital Economics. Lithuanian Governing Council member Gediminas Simkus had previously said that the anticipated increase wouldn't be sufficient to bring consumer-price growth down to the 2% target over the medium term, noting that the primary reason for this rise in inflation is energy — to varying degrees in the euro zone and Lithuania, certainly, but energy nonetheless.
Bonds slumped across the globe this week as Brent oil spiked above $105 a barrel and European natural gas prices hit the highest since late 2022, as reported by Bloomberg. In the US, 30-year yields reached levels last seen in 2007. UK bonds also fell, with two-year yields up 16 basis points at 4.86% and 30-year yields at 5.93%, the highest since 1998, with traders also upping bets on Bank of England interest-rate hikes to 110 basis points of tightening by the end of next year, from 89 basis points on Wednesday. Escalating tensions in the Middle East have added to inflation concerns, with attacks involving the United States and Iran since late August on military, shipping and energy assets across the region driving oil prices back above $100 a barrel. The rise in crude prices has revived concerns about imported inflation across the fuel-dependent euro zone, potentially complicating the ECB's efforts to bring price pressures under control. ECB President Christine Lagarde warned that higher energy costs are set to feed through gradually to core and food-price inflation, saying "The conflict in the Middle East and recent developments in Russia's unjustified war against Ukraine have pushed the path of energy prices up further. This is likely to keep headline inflation well above target into the first half of 2027." The rise in bond yields is "not a euro specific issue" and the central bank is watching moves at the long-end of the curve closely, according to Bloomberg.
