UBS expects the European Central Bank to raise interest rates in June and September

Investing.com - UBS now expects the European Central Bank (ECB) to raise rates by 25 basis points in June and September, respectively, which would bring the margin rate to 2.5%, the bank’s economists wrote in a report published Thursday.

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The revision was made after the ECB’s March forecasts and communications shifted to a more hawkish stance, which came as a surprise to UBS economists. The bank’s updated staff forecasts show a significant upward revision to inflation expectations, while GDP growth expectations are revised down only moderately—an implication that points to tighter policy.

“Partly for reasons that appear to be that the ECB expects wages to respond to the surge in energy prices, thereby amplifying the impact on inflation, while cushioning growth damage,” the economists led by Reinhard Cluse said in the report.

ECB President Christine Lagarde last week reinforced this framework, saying that the memory of inflation overshooting in 2022-23 “is still fairly fresh,” meaning that firms and unions may adjust prices and wage demands relatively quickly.

UBS expects the ECB to raise rates on June 11, when it will also publish the latest macroeconomic forecasts, pause rate hikes in July, and then raise rates again in September, when it will provide another set of forecast data.

“We believe that, at the April 30 meeting, the evidence regarding the occurrence of second-round effects and their strength will still be incomplete, while it may become clearer by June 11,” the economists said.

This outlook carries risks in both directions. On the hawkish side, UBS said that if energy prices rise further, March inflation data comes in above expectations, or early signs of second-round effects emerge, the ECB could take action as early as late April. A sequence of rate hikes in June and July—rather than in June and September—is also possible.

In addition, if the Iran conflict proves to be long-lasting, the ECB may eventually raise rates more than twice and may consider steps of 50 basis points.

On the dovish side, if the Iran conflict is credible and eases quickly, leading to falling energy prices, the ECB may completely avoid rate hikes, or limit itself to a single rate hike. The economists also pointed to the risk that the euro zone economy could suffer a “more significant hit”—through supply constraints, energy rationing, or a sharp rise in unemployment—which in that case may require the ECB to cut rates.

Looking further ahead, UBS expects inflation to reach a year-on-year peak of 3.4% in May, before falling to 3.2% by end-2026, 2.1% by end-2027, and 2% by end-2028. If the ECB raises rates to 2.5% as expected, the bank expects that, as inflation returns to target, and in the absence of new shocks, the ECB would cut rates by 25 basis points in the fourth quarter of 2027 and in the first quarter of 2028, respectively.

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