Nomura strategists expect the European Central Bank (ECB) to raise rates this week, taking the depo rate to 2.50%, and to keep it there for the foreseeable future. They see another hike after a 2025 cut back to neutral to counter Iran war-related inflation risks, and do not foresee ECB rate cuts in coming years.

ECB seen hiking and staying elevated

“We expect the ECB to raise rates this week, following its June hike. We think the central bank will raise rates again after cutting to around neutral in 2025 to signal that it will counter any second-round inflation effects from the Iran war. We do not forecast further rate hikes from the ECB after September, but highlight that risks to our forecast are skewed squarely towards further hikes due to ongoing tensions in the Middle East, and we do not foresee any ECB rate cuts in the coming years.”

“Euro area GDP growth has been close to potential in recent quarters. If we exclude volatile Ireland from the GDP calculations, it has been fairly stable at around 0.3% q-o-q since the start of 2024. This rate of growth is in line with the plausible range of estimates for potential economic growth (0.27-0.33% q-o-q), which we think increases reasons to raise the ECB’s depo rate.”

“However, there has been a more recent shift in estimates of nominal neutral ranges by central banks with the ECB’s estimate moving up from around 1.25%-2.50% in H2 2023 to 1.75%-2.50% in 2026 (i.e. a higher lower bound and midpoint), while the Riksbank’s estimate is lower than in recent years (albeit updated infrequently) and is 1.50%-3.00%. Thus, with the ranges now sharing similar midpoints, the two central banks have naturally seen more aligned policy rates in recent years, while Sweden’s lower bound – now below the ECB’s – explains the Riksbank’s lower policy rate at present.”

“While at times their policy rates have moved closely together, the Riksbank, Norges Bank and SNB do not necessarily follow ECB policy. All of these European central banks are facing the effects of the global energy price shock due to the Iran war at present, making them more likely to raise rates. However, different pre-existing inflation backdrops, levels of rates compared to neutral, FX moves and policy rate transmission mechanisms, among other structural reasons, create different policymaker reaction functions.”