ECB flags inflation expectations and demand as key to next rate move

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ECB flags inflation expectations

Highlights

ECB's Schnabel highlights potential impact of persistent energy price increases on inflation expectations, currently remaining around the ECB's 2% target.
Markets price in up to four more ECB rate hikes over the next year after two expected rises in response to recent energy-driven inflation.
Schnabel notes higher global borrowing costs and strong credit dynamics may mean interest rates are not yet restrictive enough for medium-term inflation control.

Policy signals from Luxembourg speech

As reported by Reuters, Schnabel says the first issue for the ECB is whether a more persistent increase in energy prices feeds into inflation expectations after a prolonged period of elevated post-pandemic inflation.

She says most measures of longer-term inflation expectations remain around the ECB's 2% target, partly because of the central bank's previous rate increases. In her Luxembourg speech, she says monetary policy can allow a more gradual return of inflation to target as long as expectations stay firmly anchored and the ECB maintains credibility on price stability.

The second factor is whether demand across the economy remains stronger than expected, since companies can pass higher costs on to consumers more easily when growth holds up. Schnabel also points to the recent rise in global borrowing costs, driven in part by higher U.S. yields, as a third element that could shape the policy outlook.

Implications for euro zone rates and growth

Markets currently expect as many as four additional ECB rate moves over the next year after the central bank raises rates twice this year in response to an energy-driven inflation surge. Schnabel does not spell out her preferred path, but she says these domestic and external forces could either strengthen or weaken the case for further tightening.

She adds that some models indicate the latest jump in borrowing costs could weigh on growth more heavily than the ECB currently projects, which would in turn reduce medium-term inflation pressures relative to the baseline outlook. At the same time, she says robust credit dynamics suggest interest rates may still not be restrictive enough, and that the level considered restrictive could now be higher than previously thought.

In our earlier coverage of resilient credit markets in late 2026, we noted that stability was increasingly resting on a narrower base—continued technology capex and investors’ willingness to absorb higher yields amid persistent geopolitical stress. We also explained that if yields stay elevated, higher funding costs can keep borrowing conditions tight and limit investment flexibility across sectors, making market resilience more vulnerable if demand or risk appetite weakens.

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