We forecast the ECB will raise rates by 25bp at its 10 September meeting, lifting the depo rate to 2.50%. We believe that rising price pressures, owing to the ongoing US Iran war, and the Euro area’s economic resilience, suggest a September rate hike is a done deal. We expect the ECB’s new forecasts to be moderately hawkish (i.e. stronger GDP growth and marginally higher near-term HICP inflation), but for Mme Lagarde to be non-committal and for her tone to be dovish relative to market pricing, as in June. Indeed, with markets pricing three rate hikes by summer 2027, we believe the bar is high to ‘outhawk’ markets. We expect no more rate hikes following the September hike. However, we originally assumed the Islamabad Memorandum would hold. Energy commodity prices have risen markedly since the re-escalation and remain elevated, and markets understandably now price in more ECB rate hikes by mid-2027 than they did on 6 July. We believe if the re-escalation drags on to end-September or end-October, and remains in the range $80-100/bbl, we expect the ECB to hike additionally in December. Also if the price of Brent crude oil rose to above $100/bbl and remained there until end-September or mid-October, the ECB may bring forward its December 2026 hike to October (the October meeting is 29 October). If the re-escalation is resolved by end-September, and the price of Brent crude oil falls back to pre-war levels (in the range $60-70/bbl), we believe September is likely to have been the final ECB rate hike. From a market perspective, we like 2*10 ESTR steepeners at current level of 0.27 with TP at 0.37 and SL at 0.22 & receiving 1yr-1yr ESTR at current levels of 2.95 with SL at 3.10 & TP of 2.75.
