ECB Hike Expectations May Be Overblown, Say Capital Economics

Investors may be overestimating the European Central Bank's (ECB) willingness to hike interest rates, according to Capital Economics. The research firm believes that a temporary inflation spike caused by higher energy prices will not lead to persistent wage pressures.

Capital Economics expects the ECB to raise its deposit rate again in December, taking it to 2.75% from 2.5%, but sees little need for further tightening after that. In fact, the firm forecasts that interest rates will begin to fall in the second half of 2027.

The analysts argue that 'second-round' effects on inflation through wages and profits are likely to be negligible due to a relatively tight labour market and moderate demand growth. They predict that euro zone headline inflation will climb to around 4% in December before falling sharply in 2027.

Core inflation is projected to rise to about 3% in the first half of next year as higher energy costs feed through indirectly, before easing towards 2% in 2028. Capital Economics also expects the euro zone economy to continue growing at a steady pace, with GDP forecast to expand 1.0% in 2026, 1.1% in 2027 and 1.0% in 2028.

However, Capital Economics cautioned that a prolonged disruption to energy supplies could push inflation higher and force the ECB to keep rates elevated for longer.