Key Takeaways:
Traders have boosted bets on two quarter-point rate increases from the European Central Bank before year-end, a wager Barclays strategists say is likely to begin with a second hike in September.
The ECB raised its deposit rate for the first time in roughly three years in June, and Barclays expects another quarter-point increase at the September meeting even as Eurozone inflation eased more than expected to 2.8 percent last month.
"Pipeline pressure in the system remains, with selling price expectations indicators still elevated relative to historical averages and pre-war levels," said Silvia Ardagna and Mariano Cena, strategists at Barclays, in a note. "Cost-push pressures from four consecutive months of elevated energy prices are likely to generate indirect effects outside the energy complex."
Consumer prices in the 21-member currency area rose 2.8 percent in the 12 months through June, down from 3.2 percent in May and below the 3.0 percent consensus forecast, preliminary Eurostat data showed. Core inflation, which strips out volatile food and fuel costs, decelerated to 2.4 percent from 2.6 percent, also undershooting expectations. Energy costs climbed 8.7 percent year-on-year, moderating from 10.8 percent in May, as Brent crude futures retreated to around $80 a barrel after a framework peace deal between the US and Iran eased supply fears tied to the Strait of Hormuz.
The June hike — the first by any G7 central bank to address energy-driven inflation — marked a turning point after years of ultra-loose policy. ECB President Christine Lagarde, speaking at the central banking forum in Sintra, Portugal, pushed back against characterizing the move as insurance, arguing it was robust across all inflation scenarios. She said risks to both inflation and growth have become more balanced, while other Governing Council members indicated "all options" remain on the table for upcoming meetings.
The inflation data offers the ECB room to move deliberately. While headline and core readings both eased, the Barclays strategists pointed to the European Commission's selling price expectations indicators, which remain elevated in manufacturing and retail relative to both historical averages and pre-war levels. That suggests the pass-through from higher energy costs to broader prices may still be working through the system.
The last time the ECB deployed similar language around balanced risks was in mid-2023, preceding a 25-basis-point hike at the following meeting. Overnight index swaps currently price roughly 50 basis points of additional tightening by December, implying a second move is fully discounted and a third is possible.
Rate Differentials Widen as Fed Holds Steady
A second ECB hike would widen the rate differential between the Eurozone and the US, where the Federal Reserve has held its benchmark rate steady and markets now expect no further tightening for the rest of 2026, according to Aberdeen Investments. The euro has gained ground against the dollar in recent weeks as the rate outlook diverged, while European government bond yields have risen, with the German 10-year Bund yield climbing to around 3.1 percent. Higher borrowing costs could weigh on the Euro Stoxx 600, which has already pulled back from its 2026 highs as rate-sensitive sectors like real estate and utilities adjust to the new policy trajectory.
The ECB's next policy decision is scheduled for September 12. If inflation holds near current levels or ticks higher on energy pass-through, the case for a hike strengthens. But a sharper-than-expected slowdown in growth — or a renewed drop in oil prices — could give the doves ammunition to argue for a pause.
This article is for informational purposes only and does not constitute investment advice.
