The European Central Bank is widely expected to maintain interest rates unchanged at 2.25% at its July 23 policy meeting, following June's surprise rate hike that made the central bank the first among the world's major monetary authorities to tighten policy in response to the geopolitical fallout from the Iran conflict. According to Reuters, markets overwhelmingly expect the ECB to leave rates unchanged next week, with money markets now assigning roughly 88% probability that the central bank simply holds steady rather than tightening further. Analysts expect policymakers to use the meeting to signal their thinking ahead of September, when updated economic projections will provide a clearer assessment of inflation risks and economic growth. A recent Reuters poll shows that around 70% of economists now expect one additional ECB rate hike this year, compared with roughly 60% only a month ago, as the renewed threat of imported inflation through higher energy prices continues to influence market expectations. ING's Carsten Brzeski notes that while the 23 July ECB meeting initially looked like a formality, renewed Middle East tensions and rising oil prices have restored the macro backdrop seen before the June meeting, with some ECB officials potentially inclined to push for another rate hike.
Energy prices have been rising following tit-for-tat strikes by the U.S. and Iran, with maritime traffic through the vital Strait of Hormuz chokepoint effectively shut down. Brent crude futures touched a five-week high on Monday, while benchmark Dutch wholesale gas prices rose to their highest intraday level in four months on the same day, adding to worries about inflation. According to The Economic Times, Brent crude futures remained elevated near $90 per barrel, threatening the inflation outlook and strengthening the case for tighter European Central Bank policy. The current oil futures curve remains broadly within the range of scenarios incorporated into the ECB's June forecasts, suggesting that recent developments have not materially altered policymakers' outlook. Meanwhile, the U.S. inflation picture continues to move in the opposite direction, with June consumer prices posting their largest monthly decline since April 2020, bringing annual inflation down to 3.5%, well below the 3.8% consensus forecast. As per Bloomberg, Brent crude rose to $91 a barrel as mediators work toward reviving a truce between the U.S. and Iran, with the surge in crude oil prices stoking concern that inflationary pressures will prompt the Federal Reserve to raise interest rates.
Euro zone government bond yields inched higher on Tuesday as oil prices remained elevated near $90 per barrel, with Germany's 10-year bond yield up 1.5 basis points to 3.165%, its highest level in eight weeks. According to The Economic Times, Germany's two-year bond yield, which is sensitive to changes in ECB policy expectations, was up 0.5 bps at 2.781% after touching a two-year high of 2.8174% on Monday. Further ahead, investors were pricing in about 45 basis points of tightening from the ECB by the end of the year, or the equivalent of about two quarter-point rate hikes. The Governing Council stressed it would remain data-dependent and meeting-by-meeting, with no pre-commitment to any rate path. Despite the moderation in price and wage expectations, firms' longer-term inflation outlook remained broadly stable, with inflation expectations for one year and three years ahead holding steady at 3.0%, while the five-year expectation edged up to 3.1% from 3.0% in the previous survey. Meanwhile, the U.S. Treasury market fell, pushing 10- and 30-year yields to the highest levels in about two months, with the 10-year yield rising to touch its highest since late May at 4.64%, as a surge in crude oil prices stoked concern that inflationary pressures will prompt the Federal Reserve to raise interest rates.
On the dollar side, new Fed Chairman Kevin Warsh struck a hawkish tone during his first congressional testimony, pledging a firm commitment to price stability, yet his remarks failed to lift the greenback. That is largely because June's non farm payrolls report landed at just 57,000, a significant miss that cooled expectations for further Fed tightening. June's CPI also slowed to 3.5% year over year from 4.2% in May, reinforcing the case for the Fed to hold at its July 29 meeting. Interest-rate futures showed traders see about 20% chance that the Fed will raise interest-rate at the policy meeting next week, with Fed Chairman Kevin Warsh having repeatedly emphasized that inflation remains a concern for the central bank. This divergence between Fed and ECB policies has created a complex dynamic for currency markets, with the euro finding support from the ECB's hawkish pivot while facing headwinds from the Fed's more dovish stance. The collision of these two central bank paths, combined with a Middle East conflict that keeps rewriting the inflation outlook on both sides of the Atlantic, has shaped price action in euro futures significantly.
