ECB Poised for Third Hike as Bond Yields Rise, Equities Stumble

The European Central Bank is widely expected to raise its deposit rate by 25 basis points to 2.5% on Thursday, a move that would mark its third increase in the current cycle. European bond yields rose this week, snapping a two-day rally, while equities ended a cautious session on a mixed note as investors weighed the rate decision against rising energy prices tied to the US-Iran conflict.

**Bond Yields Climb**

European government bond yields have risen sharply this year. Germany's 10-year bund has climbed 50 basis points, while equivalent yields in France and Italy have each risen around 65 basis points, according to rte.ie. Eurozone yields pushed higher with crude oil near $100 a barrel and the ECB hike imminent, Investing.com reported. The selloff in global bonds has tightened financial conditions, doing some of the central bank's work. State Street's head of macro strategy, Michael Metcalfe, said the ECB is likely to stress that only if moves are out of line with fundamentals would it act, as reported by rte.ie.

**Equities Mixed**

European stocks closed on a mixed note Wednesday. The pan-European Stoxx 600 ended down 0.19%, as reported by RTTNews. France's CAC 40 edged down 0.07%, while the UK's FTSE 100 gained 0.32% and Germany's DAX rose 0.27%. Earlier in the week, European markets edged lower with the ECB decision in focus, according to Seeking Alpha. Investor sentiment was dampened by a profit warning from ASML and Nvidia's announcement of $5.5 billion in charges due to new US export controls, RTTNews reported.

**Inflation and Energy**

Eurozone inflation rose back above 3% in August on higher energy costs, with Brent crude near $100 a barrel and natural gas at levels last seen in early 2023, rte.ie reported. The US-Iran conflict has disrupted shipping through the Strait of Hormuz, which rte.ie called a "swing factor" for the ECB's future decisions. "The waterway has become the swing factor for the ECB's future decisions, because a prolonged disruption would turn an energy-price shock into a broader inflation problem," Dennis Shen of TU Berlin's International School of Management told The Business Times.

**Divergence in Rate Expectations**

Economists surveyed by Bloomberg and published by The Business Times overwhelmingly expect the deposit rate to stay at 2.5% through 2027 after Thursday's hike. Traders, by contrast, are pricing about three more rate increases by mid-2027, highlighting a sharp divergence. "The ECB is likely to present a 25 basis-point hike as a necessary step, but it'll probably stop short of guiding markets toward another hike," said Ken Egan of Kroll Bond Rating Agency Europe, as reported by The Business Times. ING's global head of macro Carsten Brzeski called the expected move "another insurance hike" or "a dovish rate hike," according to rte.ie.

ECB policymakers have little appetite to signal further increases. Still, some Governing Council members have hinted at more action. Lithuania's Gediminas Simkus said a hike next week "isn't going to be enough," while Bulgaria's Dimitar Radev referred to both September and December as "live" meetings, The Business Times reported. Executive Board member Isabel Schnabel told Bloomberg it is "critical" to prevent second-round effects early.

**Economic Data and Outlook**

Eurozone inflation in March was confirmed at 2.2%, according to RTTNews, but the more recent August reading showed a jump above 3%. Services inflation fell despite the August uptick, and wage growth is still slowing, rte.ie reported. The ECB is expected to revise its 2026 growth forecast slightly higher after the economy proved stronger than anticipated, with business activity posting solid growth in August, The Business Times said. A prolonged energy supply disruption could shift the outlook. "The ECB can look through a temporary energy shock; it cannot afford to look through a persistent one," said Shen.