Deutsche Bank believes the European Central Bank (ECB) will settle on a 1.50% terminal rate during its easing cycle, but this may happen sooner than expected. As the year continues, attention is expected to shift from lowering rates to possibly raising them in the future. The bank has raised its prediction for euro area GDP growth in 2025 from 0.5% to 0.8%, highlighting the economy’s strength despite U.S. tariffs. Inflation is projected to fall below the ECB’s 2% target in 2025. This suggests there is still room for more rate cuts, even though the case for a 1.50% terminal rate is getting weaker. Looking ahead to 2026, Deutsche Bank predicts that increased European defense spending might enhance strategic autonomy and create a sense of “EU exceptionalism.” The ECB may start raising rates by late 2026, with a forecasted policy rate of 1.75%. The bank has also raised its terminal rate expectation for 2027 to 2.50%, citing fiscal commitments and a potentially higher neutral rate. Geopolitical events and changes in spending could lead to a more vigorous ECB response than what the market currently expects. This shifting policy landscape may affect future monetary decisions in the euro area. What we see here is a significant adjustment in expectations regarding the ECB’s rate movement. Deutsche Bank is suggesting that there may not be as many rate cuts ahead as previously thought. There’s now an implied limit, indicating that the rate-cutting trend could slow down earlier than the market believed just a few weeks ago. By raising its GDP growth forecast for 2025, the bank recognizes that the euro area’s economy is doing better than anticipated. Despite challenges like U.S. trade actions, demand remains strong enough to promote GDP growth without quickly driving prices above the ECB’s target. Inflation is expected to drop below 2% next year, which would usually encourage the central bank to keep rates low for a longer time. However, this assumption is now being questioned. This isn’t just a minor adjustment in terminal rate predictions; it’s a signal that the sentiment in Frankfurt may be shifting. It’s no longer just about lowering interest rates but also about how long those rates will stay low. The shift toward strengthening fiscal capacity in Europe, especially with increased defense spending, adds another layer to consider. Such spending is large and durable, suggesting stronger internal demand in the long term. This type of expenditure is unlikely to be easily reversed, and it could lead to more inflation down the road. This helps clarify why the bank has increased its 2027 terminal rate expectation to 2.5%. There’s no doubt that monetary policy will have to reflect this increased demand. For those planning strategies in interest rate markets, this has clear implications. The path from now might only drop slightly before leveling off – and from that level, there’s a growing chance rates could rise after 2026. Relying too heavily on positions far down the yield curve without a new assessment can be risky. It’s not just about chasing short-term gains from imminent cuts; it’s also about understanding the ECB’s future intentions beyond mid-decade. The central bank’s future seems to require more flexibility, indicating it won’t just keep lowering rates for the sake of it. Changes in global politics, new spending priorities, and a possible re-assessment of the euro area’s neutral rate are all contributing to this updated perspective. Expectations of higher rates in the medium term should influence how pricing risks are considered, particularly on the longer end. Focus should be on the subtle changes occurring further along the curve. That’s where policy thinking is heading and where current pricing may soon diverge. Market participants can no longer rely on assumptions made during the post-pandemic period. New drivers are at play now – some from outside, others from within – all pointing towards a less supportive trajectory for rates. Keeping investments based on a continuous decline in rates after the next few quarters might misinterpret how the ECB is getting ready to adjust its stance.

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