ECB seen hiking deposit rate to near 3% by late 2027 on inflation risks
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Money markets are pricing a more hawkish European Central Bank, with the deposit rate seen reaching almost 3% by late 2027. Bets on additional tightening are gaining momentum as geopolitical tensions keep inflation pressures elevated. The ECB is expected to raise rates in September after a June hike.
Key Facts
- Markets price a roughly 25% chance of the ECB deposit rate reaching 3% by March 2027 and an about 60% chance by September 2027.
- The ECB is expected to raise rates in September, after tightening in June to contain price pressures from the U.S.-Iran war-induced energy shock.
- Oil prices are trading at over $90 a barrel, down from a peak of $120 in April, while physical Brent premiums collapsed from $40 to $7.
- Euro area natural gas storage levels are at the lowest for this time of year in over a decade.
- MUFG senior economist Henry Cook said a durable Middle East peace deal remains the baseline assumption before the U.S. midterm elections in November.
Rate Hike Expectations
Money markets are bracing for an increasingly hawkish European Central Bank, wagering that geopolitical tensions will complicate its inflation battle and keep price pressures stubborn enough to lift the key deposit rate to almost 3% by late 2027. The ECB is expected to raise rates in September, after tightening in June to contain price pressures unleashed by the U.S.-Iran war-induced energy shock. In addition to an anticipated September rate increase that would take the deposit rate to 2.5%, bets on additional tightening are gaining momentum. Markets price a roughly 25% chance of the ECB deposit rate reaching 3% by March 2027 and an about 60% chance by September. Just a month ago they priced no chance of a move to 3% by March.
Inflation Drivers
Analysts say it's not just elevated oil prices, trading at over $90 a barrel, that are keeping investors on edge, but also the risk of tighter supplies of refined fuels, thin euro zone gas inventories and a conflict that could drag on beyond November's U.S. midterm elections. Rate hike bets held up even as oil pulled back from a peak of $120 hit in April and physical Brent premiums collapsed from $40 to $7, suggesting traders remained worried about inflation and the ECB reaction even if oil retreats. Mark Dowding, chief investment officer at BlueBay Fixed Income, said crack spreads will remain elevated for the foreseeable future, with the markets for refined products far tighter than is the case for crude. Euro area inflation is also driven by the natural gas market, with storage levels at the lowest for this time of year in over a decade amid expectations the region will fall short of its goal before the winter.
Geopolitical Risk
The baseline assumption is that a durable Middle East peace deal remains achievable before the U.S. midterm elections in November, said MUFG senior economist Henry Cook. But if that starts to seem out of reach and energy pricing moves closer towards the ECB's adverse scenario, we could see something more akin to a fully-fledged tightening cycle, he added, mentioning a deposit rate to at least 3%. Investors warned that the war could weigh on the energy market long-term, fuelling inflation.
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ECB seen hiking deposit rate to near 3% by late 2027 on inflation risks
