The European Central Bank raised interest rates by 25bp and said it remains ready to tighten further, as inflation stays above target. Staff projections show core inflation remaining above 2% through 2028, with a 2.2% reading pencilled in for that year; core inflation is also forecast at 2.5% this year and 2.5% in 2027. Inflation projections were revised higher for both 2026 and 2027, while growth forecasts were revised down for this year and next compared with March.
Market expectations embedded in the ECB’s 2028 projections assume around three rate hikes in total, implying policy may need to tighten more than three times to bring inflation back to target. Current pricing indicates uncertainty over whether the next 25bp move comes as soon as July, and expectations could shift with incoming data and developments in the Middle East. A path of three further 25bp increases would take the ECB’s deposit rate to 3% by the October meeting.
Implications For Market Expectations And ECB Policy Outlook
We see the European Central Bank signaling a readiness to tighten policy further, as inflation remains the primary concern. Recent data shows Eurozone core inflation is holding around 2.7%, which is stubbornly above the 2% target. This persistence supports the view that more rate hikes are likely, even with modest economic growth projections.
For derivative traders, this suggests that the market may be under-pricing the potential for future rate increases. We believe positioning for higher short-term interest rates is the correct move in the coming weeks. This could involve using instruments like Euribor futures to bet on a higher deposit rate by the end of the third quarter.
Trading Strategies And Historical Context
Given the ongoing uncertainty from geopolitical conflicts impacting energy prices, we expect continued volatility in rate markets. Traders should consider using options, such as interest rate swaptions, to capitalize on potential sharp moves. These strategies can offer upside exposure to a more aggressive ECB while managing downside risk.
Looking back at the 2022-2023 period, markets repeatedly underestimated the ECB’s commitment to fighting inflation. We see a similar pattern emerging now, where official communication points more hawkishly than current market pricing. Therefore, we believe there is more upside potential than downside risk for euro-area rates from here.
