Energy prices may force ECB's hand over rate hikes as bank's economic projections leave

EUR/USD has been selling off slightly after the ECB decision to raise interest rates today. This, however, might have more to do with the jump in oil prices and worsening terms of trade, with Brent rising above $105/bbl today on US-Iran war escalation concerns.

Market expectations coming into the meeting were very hawkish – and the communications from the ECB can be read as at least having a hawkish tilt. President Lagarde repeated her mantra that decisions will be taken on a meeting-by-meeting basis and are data dependent. However, she did not push back against hawkish market expectations. She signalled that inflation is proving more persistent than expected, talked up the resilience of the Eurozone economy, and played down the importance of the "neutral rate" (which we thought could keep the ECB wary of hiking further beyond today).

The bank's economic projections also have a hawkish aftertaste: 2027 and 2028 inflation projections were revised slightly higher, including core inflation, with the headline measure now expected to sit above target at 2.1% in 2028. Growth in the medium term, in 2026 and 2027, is also expected to be stronger than previously forecast.

Still, we are not convinced that the ECB will tighten monetary policy further beyond today, but the Governing Council is clearly doing everything it can to preserve optionality to continue hiking rates if needed. The surge in energy prices, which coincided with the bank's communications today, is a reminder that the geopolitical backdrop could still force the ECB's hand.