ECB Review: A robust hike, one more to come

For the first time since September 2023, the ECB hiked its policy rates by 25bp, bringing the deposit rate to 2.25%. The decision was motivated by the war in the Middle East “generating inflation pressures” highlighting that “the decision to raise rates is robust across a range of scenarios mapping out how the shock might evolve and affect the medium-term outlook for the euro area.” Even in a “mild scenario” where energy prices decline significantly more than implied by current futures, inflation is expected to average 1.8% y/y in both 2027 and 2028 with core inflation above 2%. With a primary objective of maintaining price stability, the ECB are thereby assessing that monetary policy needs to be tightened.

The market reacted to the new staff projections by sending European yields higher as the new staff projections showed higher inflation but only slightly lower growth (see chart). For 2026, GDP growth is seen at 0.8% y/y (from: 0.9%) and inflation at 3.0% y/y (from: 2.6%) with core at 2.5% (from: 2.3% y/y). As euro area GDP fell 0.2 % q/q in Q1 due to distortions of the Irish export data the ECB staff decided to use a modified measure of GDP for Ireland reflecting only domestic demand. For this reason, GDP growth is holding up much better than we had anticipated based on the “official” measure of GDP. As the staff projections include market expectations of around 75bp worth of hikes and only then see inflation back at 2.0% in 2028 while growth is still holding up relatively well, we expect the ECB to deliver a second hike. However, as we also expect growth to disappoint relative to their expectations even on the modified measure, we do not expect more than two hikes to be delivered.

Download the Full Report!