ECB: a hawkish hike

What happened? 

The ECB delivered a widely anticipated 25bp rate hike today, lifting the deposit rate to 2.50%. With the rate increase having been fully priced in for some time, markets focused instead primarily on any signals from the ECB regarding the future path of inflation.

Relative to those accompanying its June meeting, the ECB staff's inflation forecasts were revised upwards once again, to 2.5% in 2027 (previously 2.3%) and 2.1% in 2028 (2.0%). More importantly, the ECB raised its 2027 core inflation forecast from 2.5% to 2.6% and the forecast for 2028 from 2.2% to 2.3%. The ECB noted that it expects inflation to remain "well above target for an extended period”.

Regarding GDP growth, the ECB has become slightly more optimistic for 2027, now forecasting 1.4% (previously 1.2%), but leaves its 2028 projection unchanged (1.5%). ECB President Christine Lagarde noted that the economy was proving resilient with “broad based growth … likely to continue”. However, the ECB statement also pointed to upside risk to inflation and downside risk to growth.

What does it mean for investors? 

Inflation is now centre-stage. The new staff projections suggest that the ECB members are becoming slightly more concerned about the pass-through from commodity prices to underlying inflation and, as we note above, the ECB expects inflation to stay above target for some considerable time.

In her press conference, ECB President Lagarde explicitly highlighted upside risks to inflation stemming from higher natural gas prices and potentially rising food prices because of El Niño. She repeated her view that these higher prices might feed through to core prices gradually.  However, there were also some dovish statements too: President Lagarde said that the future ECB rate path wasn’t discussed at all at the meeting, keeping all options open. And she didn’t repeat her July statement that markets understand the ECB’s reaction function very well.

The ECB's statement coincided with a further rise in Brent crude oil prices to USD105/bbl and an increase in Dutch TTF gas prices to their highest level since late 2022.

Market reactions to the ECB meeting were subdued. Sovereign bond yields had already moved higher ahead of the meeting, mirroring developments in global fixed income markets. The EUR later recouped modest losses following the sharp increase in oil and natural gas prices.

Shortly after the ECB's statement was released, money markets were fully pricing two more 25bp hikes by March 2027 (compared to by April before today’s meeting) and one additional hike by June 2027.

We however expect the ECB now to pause further rate hikes and evaluate the impact of previous tightening on the economy and inflation outlook. Nevertheless, higher energy prices and increases to inflation forecasts increase the risk of another hike this December.