Excessive pricing for ECB terminal rate

Growth momentum indicators like the PMIs continue to paint a picture of economic resilience in the euro area that, together with core inflation still running above target and the Iran war dragging on without a clear ending in sight, gives the ECB sufficient justification to keep raising rates.

A 25 basis point hike from the Governing Council this week is fully priced in by swap markets, so anything less would be not just a major shock but a big disappointment for investors. The more important question for currency markets is whether there is any pushback against expectations for a 3% terminal rate in 2027.

We think this pricing is excessive, particularly as any further hikes beyond this month's meeting would push the terminal rate into restrictive territory - a move too far, in our view, given the growth risks and the fact that the inflation problem remains almost entirely due to supply-side issues.

The common currency, however, continues to trade mostly off the news in the US for now, so we expect limited fallout from the meeting’s headlines.