Energy shock fuels inflation, ECB rate hike expectations

Ms. Schnabel reported that euro area financial markets remained driven by the Middle East conflict and its impact on energy prices.

Markets continued to price in a persistent oil price shock, leading to a notable and sustained inflationary impact.

Inflation fixings for both 2026 and 2027 increased further, suggesting investors anticipated indirect or second-round effects extending beyond the first year of the conflict, before inflation returns to the 2% target in 2028.

The balance of risks to inflation over the next two to five years remained clearly tilted to the upside.

This persistent energy price outlook was reflected in sharply increased inflation compensation and higher short and longer-term interest rates.

Investors were pricing in cumulative ECB policy rate hikes of 73 basis points in 2026, with a 25 basis point hike fully priced by June, two by September, and a 92% probability of a third by December.

Despite the inflationary outlook, risk asset markets, including equities, sovereign and corporate bond spreads, and the euro's exchange rate, had largely recovered to pre-conflict levels.

Earnings expectations were revised up, consistent with a view that the economic growth impact would be short-lived.

Financial conditions had eased since the previous meeting, mainly driven by buoyant risk asset markets, though they remained somewhat tighter than before the war.

Ms. Schnabel also summarised the rise of tokenised financial markets, noting their rapid expansion in stablecoins, decentralised finance, and tokenised traditional assets.

She highlighted potential efficiency gains, such as reduced bond issuance costs and mitigated settlement risk, while acknowledging fragmentation of liquidity as a key central bank concern.

The Eurosystem's Pontes and Appia projects aim to foster these developments.