Traders are bracing for an increasingly hawkish ECB

Money markets are bracing for an increasingly hawkish European Central Bank, wagering that geopolitical tensions will complicate its inflation battle and keep price pressures stubborn enough to lift the key deposit rate to almost 3% by late 2027.

The ECB is expected to raise rates in September, after tightening in June to contain price pressures unleashed by the U.S.-Iran war-induced energy shock.

Markets price a roughly 25% chance of the ECB deposit rate reaching 3% by March 2027 and an about 60% chance by September. Just a month ago they priced no chance of a move to 3% by March.

Inflation could prove stickier than expected as expansionary fiscal policy, green-transition investment, defence spending and persistent labour market tightness reverse some of the disinflationary forces seen before the pandemic.