Traders are increasing bets on a more hawkish European Central Bank, with market pricing pointing to a deposit rate approaching 3% by late 2027. A September increase is expected to lift the benchmark to 2.5%, according to economists and derivatives pricing tracked on Thursday.
The five-year euro short-term rate overnight index swap, a proxy for the euro zone’s neutral rate, reached roughly 2.85% on Thursday, underscoring the shift in policy expectations. Probabilities assigned to the deposit rate hitting 3% by March 2027 have risen to about 25%, up from no chance priced a month earlier, while the odds for September 2027 stand near 60%.
ECB policy is being shaped by persistent inflation pressures, driven in part by geopolitical risks tied to the Middle East conflict. Analysts note that a durable peace deal before the U.S. midterm elections in November could ease energy-price risks, but failure to achieve this may force the ECB into a more aggressive tightening cycle. Henry Cook, senior economist at MUFG, said a scenario closer to the ECB’s adverse case could push the deposit rate to “at least 3%.”
Energy markets remain a key concern. Brent crude oil is trading above $90 a barrel after peaking at $120 in April, while physical Brent premiums have collapsed to between $40 and $7. Natural gas inventories in the euro area are at their lowest for this time of year in over a decade, with storage levels around €65 and prices having previously surged past €170 in 2021. Hot weather has boosted air-conditioning demand, threatening to leave inventories short of winter targets.
Refined-product markets are also tightening, with crack spreads—gauging the margin between diesel and crude oil—remaining elevated. Mark Dowding, chief investment officer at BlueBay Fixed Income, said the spread compression reflects tighter markets for refined products compared with crude. Carsten Brzeski, global head of macro research at ING, added that policy-rate pricing appears to assume the war will persist until November.
Additional inflationary pressures include expansionary fiscal policy, green-transition investments, rising defense spending, and a tight labor market, all of which are reversing pre-pandemic disinflationary trends. Euro zone business activity data released on Friday showed growth at its fastest pace for the year, further complicating the ECB’s policy calculus.
