UBS has adjusted its view of the European Central Bank's (ECB) policy path and now expects two quarter-point rate increases, in June and in September, that would lift the deposit rate to 2.5%, the bank's economists said in a note published Thursday.
The bank's revision reflects the ECB's March projections and communications, which UBS said took a hawkish turn and caught its economists by surprise. In particular, the ECB's updated staff forecasts showed significant upward revisions to inflation together with only moderate downward adjustments to GDP growth - a mix that pointed toward the need for tighter monetary policy.
"Part of the explanation seems to be that the ECB expects wages to respond to the energy price spike, thus amplifying the inflation impact while cushioning the growth damage," economists led by Reinhard Cluse wrote.
ECB President Christine Lagarde reinforced that view in public remarks last week, saying memories from the 2022-23 inflation overshoot are "rather fresh," a phrase UBS interprets as suggesting that firms and labor negotiators may react relatively quickly with price and wage adjustments.
UBS's timing calls for an initial 25 basis point hike at the ECB meeting on June 11, the same gathering that will include updated macroeconomic projections. The bank expects the ECB to pause in July and then to deliver a second 25 basis point increase in September, coinciding with another round of projections.
"We think that evidence on the emergence and strength of pro-inflationary second-round effects will still be incomplete at the time of the meeting on 30 April, while greater clarity might exist on 11 June," the economists wrote.
UBS emphasized that its call carries risks in both directions. On the hawkish side, the ECB could move earlier - potentially as soon as late April - if energy prices climb further, if March inflation data surprise to the upside, or if early indicators of second-round inflationary effects become visible. In such a scenario, successive hikes in June and July rather than a June and September split are also possible.
The bank further noted that a prolonged Iran conflict could push the ECB to raise rates by more than two increments and even contemplate 50 basis point steps.
Conversely, on the dovish side, a credible and swift de-escalation of the Iran conflict that reduces energy prices could allow the ECB to forgo additional hikes or limit itself to a single rise. UBS also flagged the possibility of a more "significant hit to the eurozone economy" - for example through supply constraints, energy rationing, or a sharp rise in unemployment - in which case the central bank might need to cut rates instead.
Looking beyond the immediate policy horizon, UBS projects eurozone inflation to peak at 3.4% year-on-year in May, then to moderate to 3.2% by the end of 2026, 2.1% by the end of 2027, and to reach 2.0% by the end of 2028.
Under UBS's forecast of an ECB deposit rate at 2.5%, the bank expects the central bank to reverse course and cut rates by 25 basis points in the fourth quarter of 2027 and by another 25 basis points in the first quarter of 2028, provided no new shocks occur and inflation moves back toward target.
Key takeaways
- UBS now expects two 25 basis point ECB hikes - on June 11 and in September - bringing the deposit rate to 2.5%.
- The change follows ECB staff forecasts in March that materially raised inflation projections while trimming GDP only modestly, prompting a hawkish shift in communication.
- UBS projects inflation to peak at 3.4% in May and to return to around 2% by end-2028, with the bank forecasting rate cuts in late 2027 and early 2028 if no new shocks occur.
Sectors likely affected
- Fixed income and general rates markets, which respond directly to central bank policy expectations.
- Banking and financial services, given implications for lending margins and deposit rates.
- Real estate and corporate borrowers, where financing costs and cap-rate dynamics are sensitive to policy rates.
Risks and uncertainties
- Hawkish upside: A further rise in energy prices, stronger-than-expected March inflation, or signs of second-round inflationary effects could prompt earlier or larger ECB tightening, which would affect interest-rate sensitive sectors.
- Geopolitical escalation: A prolonged Iran conflict could lead the ECB to raise rates more than twice or consider 50 basis point steps, amplifying pressure on borrowing costs across the economy.
- Dovish downside: A swift de-escalation that lowers energy prices, or a severe economic hit through supply shortages, energy rationing, or rising unemployment, could force the ECB to scale back hikes or even cut rates.
Note: The projections and scenarios above reflect UBS's published economic forecasts and the risks it outlines; they assume no additional shocks beyond those discussed.