Traders are increasing bets that the European Central Bank will raise its deposit rate to nearly 3% by late 2027, as energy market volatility and geopolitical tensions sustain inflation pressures.
Market pricing suggests a roughly 25% probability that the ECB’s deposit rate will reach 3% by March 2027, up from 0% a month earlier. The likelihood rises to about 60% by September 2027, reflecting growing expectations of a prolonged tightening cycle. The ECB is expected to raise rates again in September, taking the deposit rate to 2.5%, following a June increase.
The shift in expectations follows a sustained period of elevated energy prices, with Brent crude trading above $90 a barrel, down from an April peak of $120. Physical Brent premiums have narrowed from $40 to $7, while natural gas prices remain historically high at around €65, compared with peaks above €170 in 2021. The five-year euro short-term rate overnight index swap, a proxy for the neutral policy rate, reached approximately 2.85% on Thursday.
Analysts cite multiple drivers behind the repricing, including tight euro zone gas inventories, reduced refining capacity amid the war in Ukraine, and the risk of a prolonged U.S.-Iran conflict. Natural gas storage levels are at their lowest for this time of year in over a decade, partly due to hot weather boosting demand for cooling systems. Crack spreads, which measure the margin between refined products and crude oil, remain elevated, signaling persistent oil-related inflation pressures.
MUFG senior economist Henry Cook noted that a durable Middle East peace deal before the U.S. midterm elections in November could ease energy price risks, but warned that delays or escalation could push the ECB toward a more aggressive tightening path, potentially lifting the deposit rate to at least 3% in an adverse scenario. BlueBay Fixed Income’s Mark Dowding highlighted the sustained tightness in refined product markets, exacerbated by the war in Ukraine, while ING’s Carsten Brzeski suggested that market pricing reflects expectations of a prolonged conflict extending into November.
The ECB’s policy path remains contingent on energy market developments and geopolitical stability, with traders closely monitoring storage levels and supply disruptions as key indicators of future inflation dynamics.
