The European Central Bank’s strong focus on inflation risks suggests that policymakers may remain inclined to raise interest rates again, even as economic growth in the eurozone remains weak, according to analysts at Bank of America Group.
The bank noted that the European Central Bank still attaches great importance to the risks of rising inflation, even though its official inflation target is symmetrically 2%.
Officials have repeatedly affirmed their commitment to maintaining price stability, with recent policy decisions reflecting a greater concern about inflation remaining above target than falling below it.
Attention is focused on the European Central Bank's quarterly economic forecasts, particularly its inflation projections at the end of the time horizon, which help investors anticipate policymakers' views on future interest rates.
According to the bank, the European Central Bank's June forecasts were largely in line with market expectations of two to three additional interest rate hikes during the current tightening cycle.
Policymakers had raised the deposit rate to 2.25% earlier this month, continuing to emphasize a data-driven approach that is assessed meeting by meeting.
The research team currently expects one more interest rate hike in July, although the drop in oil prices following recent developments in the Middle East has increased the likelihood of this being postponed to September or paused temporarily.
In the longer term, economists expect the European Central Bank to begin easing its monetary policy in 2027, as inflationary pressures subside.
Interest rates may eventually return to around 2%, with the possibility of falling below that level if inflation comes in below target and growth remains weak.
Aside from interest rates, investors are also watching the shrinking balance sheet of the European Central Bank.
The quantitative tightening resulted in the balance sheet declining from its peak of €8.3 trillion in 2022 to around €6.3 trillion by the end of 2025, with expectations of further declines as maturing assets are not fully reinvested.
The decline in excess liquidity may ultimately affect money market conditions and increase demand for European Central Bank funding operations.
Accordingly, balance sheet developments are likely to gain greater importance in monetary policy expectations alongside interest rate decisions.
