Hawkish ECB on Horizon as Geopolitics Complicate Inflation Battle

Traders are preparing for an increasingly hawkish European Central Bank (ECB) amid geopolitical tensions that could complicate its inflation battle. According to Euronext Markets, money markets expect the ECB to raise rates in September, with bets on additional tightening gaining momentum. Analysts say it's not just elevated oil prices, trading at over $90 a barrel, but also the risk of tighter supplies of refined fuels and thin euro zone gas inventories that are keeping investors on edge.

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. Analysts said it's notable that rate hike bets held up even as oil pulled back from a peak of $120 hit in April.

“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.