European Central Bank policymakers are increasingly prepared to raise interest rates at their September 9-10 meeting, as they seek to contain inflationary pressures stemming from the ongoing Iran war. According to Reuters, the ECB is expected to raise its policy rate to 2.50% from 2.25% in September, with the move already incorporated into the central bank's June economic projections. The move would reinforce the ECB's efforts to prevent a repeat of the severe inflationary episode that followed Russia's invasion of Ukraine in 2022. Despite the expected September increase, policymakers appear reluctant to provide guidance pointing toward another series of rate hikes, keeping future decisions dependent on incoming economic and inflation data. As per Commerzbank rates strategist Erik Liem, "Bunds are unable to hold their gains from previous sessions in the face of higher oil prices."
Eurozone government bond yields experienced a modest uptick on Thursday as oil prices rebounded slightly from recent declines, with traders viewing the latest U.S. sanctions against Iran as preferable to further military escalation. According to The Economic Times, Germany's 10-year bond yield rose just under 1 basis point to 3.234%, while the 2- and 30-year yields also rose similar amounts to 2.829% and 3.741% respectively. Money markets were pointing to 43 basis points of further ECB tightening this year, little changed from Wednesday's close but down around 2 basis points from a week earlier. The German 30-year yield had previously reached a 15-year high of 3.787% last week, while France's 10-year yield was 1 basis point higher at 4.084%, though it remained below last week's 18-year high of 4.143%. However, recent developments show Germany's two-year government bond yield rose 2 basis points to 2.86%, putting it on course for a weekly increase of about 4 basis points even as oil prices declined on Friday and were headed for their first weekly fall in three weeks.
Markets are now pricing the ECB deposit rate at around 2.80% by March next year, compared with its current 2.25% level, with longer-term expectations showing the rate at around 2.90% by late 2027. According to Reuters, pricing implying roughly a 60% probability that the ECB could eventually raise rates to 3% has kept pressure on short-dated German bonds, which are particularly sensitive to changes in monetary policy. The rate expectations reflect continued caution among investors as markets assess the outlook for inflation, monetary policy and global interest rates. Attention is also turning to Federal Reserve Chair Kevin Warsh's first speech at the Jackson Hole Economic Policy Symposium, scheduled for 1400 GMT, with investors looking for signals on the US economic outlook and the future direction of Federal Reserve policy.
Diplomatic negotiations surrounding the Strait of Hormuz remain ongoing, despite conflicting messages from involved parties. According to The Economic Times, Qatar's prime minister will visit Tehran on Thursday in an effort to relaunch diplomacy between the U.S. and Iran, with both sides at odds over control of the waterway. Iran's Revolutionary Guards said on Wednesday that Iran and Oman had agreed how to share the waterway and its revenues, but a senior Iranian source later said the two countries were still working on the details of an agreement. The Strait of Hormuz represents a critical chokepoint, as 20% of the world's energy typically flows through it. Traders appear to anticipate minimal additional monetary tightening from the European Central Bank, with sources telling Reuters that ECB policymakers have little appetite to signal further tightening after the September meeting.
The eurozone economy has shown signs of resilience, with business activity data released indicating that private-sector activity expanded at its fastest pace of the year. According to The Economic Times, data on Tuesday showed the German economy grew by 0.3% in the second quarter, above the preliminary reading of 0.2%, while business morale hit its highest level in a year in August. Recent output figures and business surveys have pointed to continued resilience, giving policymakers greater room to focus on containing inflation without imposing excessive pressure on growth. This economic resilience could give policymakers greater scope to maintain or increase borrowing costs if inflation remains above target.
