The European Central Bank is being pushed toward a firmer interest rate hiking cycle as the conflict in the Middle East feeds higher energy costs while growth in the Eurozone cools. In a fresh "European Economic Perspectives" note, UBS now anticipates the ECB will raise rates by at least two 25-basis-point increments this year, taking the policy rate to 2.5% by September.
UBS highlights the persistence of elevated energy prices as the main force behind its revised view. Those energy costs, originating from the regional conflict, are beginning to ripple into broader consumer prices, prompting the bank to reassess the likely path of monetary policy.
While UBS currently lays out a scenario with rate increases in June and September, the research team stresses that the "balance of risk is skewed towards earlier, faster or larger rate hikes." The report explicitly notes that the Governing Council could act at its April 30 meeting if it finds "sufficient evidence of pro-inflationary second-round effects."
UBS also frames the situation succinctly: "The Middle East conflict is confronting central banks with new challenges, above all, higher inflation and slower growth." That description captures the dual pressures confronting policymakers in Frankfurt: the need to rein in inflation connected to energy while avoiding policies that could deepen an already fragile slowdown across the Eurozone.
The UBS analysis points to a classic stagflation trade-off. On one hand, raising rates is the traditional response to curb energy-driven inflation. On the other hand, such tightening risks further cooling an economy that UBS describes as fragile. The report warns that the ECB's present baseline view may be too dovish if disruptions to oil and gas supplies persist through the second half of the year.
UBS further signals that the central bank could ultimately be forced to deliver more than the currently forecast two hikes to defend price stability if supply restrictions remain in place - a decision that would be taken irrespective of the negative consequences for Eurozone GDP growth.
Other European central banks are not on identical paths. UBS expects the Bank of England to adopt a prolonged hold on rates, with the next significant move anticipated to be a cut in late 2026. The Swiss National Bank is projected to keep its policy rate at 0% through mid-2027, with UBS citing a strong Swiss franc as a buffer against imported energy inflation. In Sweden, the Riksbank is forecast to maintain its policy rate at 1.75%, supported by a downward trend in domestic inflation.
For the ECB, a particular external variable remains the outcome of the "Safe Opening" talks in Islamabad. UBS says if those negotiations fail to reopen the Strait of Hormuz, the central bank could find itself compelled to deliver additional rate increases to secure price stability, even if such action further depresses Eurozone growth.
Implications for markets and sectors: The UBS view underscores the potential for renewed volatility in fixed income and currency markets as expectations for ECB policy adjust. Energy markets and sectors sensitive to interest rates, including financials and cyclical industrials, are the most directly implicated by the scenarios UBS outlines.