Markets Now Pricing in ECB Rate Hike
European government bonds have tumbled as markets rapidly reprice for an ECB rate hike, a scenario once considered fringe but now seen as the base case. The shift is driven by the war-fueled oil surge, with bets on rate cuts later this year all but evaporating amid fears of reaccelerating inflation.
The rapid shift in market sentiment follows a surprise uptick in Eurozone inflation, which rose to 1.9% in February from 1.7% in January. More concerning for policymakers is the core inflation figure, which excludes volatile energy and food prices and climbed to 2.4%, driven by a 3.4% annual rate in the services sector. Just a week ago, markets were pricing in a 55% probability of an ECB rate *cut* by the end of the year. That has completely reversed, with traders now seeing an 80% chance of a 25 basis point rate *hike* in 2026. This repricing has caused euro area sovereign bond yields to jump by more than 10 basis points. The primary catalyst for this change is the surge in energy prices, with Brent crude futures climbing past $85 a barrel amid geopolitical tensions in the Middle East. The ECB's own projections indicate that a sustained 14.2% increase in oil prices could push headline inflation up by 0.5 percentage points. European Central Bank officials are publicly urging caution, with some seeking to avoid comparisons to 2022, when the bank was criticized for acting too slowly as inflation surged after Russia's invasion of Ukraine. Bank of France Governor François Villeroy de Galhau has stated he currently sees no justification for a rate hike. However, other policymakers are signaling a need for flexibility. ECB Vice President Luis de Guindos acknowledged that a prolonged conflict could alter the bank's policy stance. Similarly, Governing Council member Yannis Stournaras has emphasized that while the ECB is not in a rush, it must remain alert to upward pressure on inflation.
