Hawkish ECB Anticipated Amid Persistent Inflation and Energy Risks

Investors are anticipating an increasingly hawkish European Central Bank (ECB) as inflation and energy market risks persist. Money markets expect the ECB to raise interest rates in September, following a tightening in June aimed at containing price pressures triggered by the U.S.-Iran war-induced energy shock.

The expected rate hike has pushed bets on additional tightening momentum, with markets pricing a roughly 25% chance of the ECB deposit rate reaching 3% by March 2027 and about 60% by September. This is up sharply from near-zero just a month ago, despite lower Brent premiums and oil prices easing.

Analysts point out that traders remained worried about inflation and the ECB's reaction even if oil retreats. '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.