Rates Spark: Oil still key to ECB outlook

The ECB hiked yesterday, as expected, but during the meeting markets were probably looking for a clearer commitment to future hikes to sustain the hawkish pricing. Nevertheless, the broader rates picture hasn’t really changed. Markets continue to see a considerable chance of a July hike and are sticking to the view of two to three hikes in total. We still think two hikes are more realistic, but until we have more clarity on second-round inflation risks, we won’t push hard against current pricing. And July seems like a realistic possibility too for the second hike, especially given the latest comments from governing council members who don't seem to push against that idea.

The big unknown remains oil, which continues to make big swings every day. This morning we're below $90 for the first time. Even though just yesterday, US President Donald Trump threatened a military escalation. We think Brent oil can also still easily make a move above $100 again. The longer the conflict remains unresolved, the more supply shortages will feed into higher prices. This could already happen in July and potentially be a trigger for the next ECB hike.

In our scenario where oil surges far above $100 for sustained periods, we see three hikes by the ECB. But we shouldn’t discount the associated growth risks with tightening monetary policy. Higher oil prices will initially pose upward pressure on rates, but as inflation starts coming down in 2027, we will likely face a worsening economic outlook. In that case, the ECB would have to consider a steep easing path in 2027 and 2028, which would also bring longer rates down sharply.