UBS anticipates that the European Central Bank's reaction to a recent jump in consumer prices will be confined to near-term interest-rate increases, with a return to easing in 2027 after the current inflation shock subsides.
Official data show inflation in the euro area accelerated in May, reinforcing market expectations that the ECB will lift borrowing costs at its next policy meeting. Eurostat reported annual consumer price inflation of 3.2% in May, up from 3.0% in April. Core inflation, which excludes volatile food and energy components, rose to 2.5% from 2.2%. Services inflation also increased, climbing to 3.5% from 3.0%.
Against that backdrop, the ECB is widely expected to deliver its first interest-rate increase since September 2023, reflecting concerns that a rise in energy costs may feed through into wages and wider price pressures.
UBS said it expects policymakers to raise rates in June and to most likely follow with an additional increase in July, while noting that the timing of any second move will depend on incoming economic data. The bank highlighted a shift toward a more hawkish posture among ECB decision-makers as input costs accelerate at the fastest pace in three and a half years and selling-price inflation picks up.
At the same time, UBS argued that the current surge in inflation is a price shock driven primarily by energy costs rather than a broad-based demand overheating. That distinction, the bank said, limits the case for sustained, aggressive monetary tightening.
"Assuming there is little risk of second-round inflation effects through higher wage demands, which we currently view as unlikely, we expect the ECB to lower rates again in 2027 once the inflation shock passes."
UBS analysts also pointed to signs of weakening economic activity as a further constraint on how far policymakers can tighten. The eurozone composite Purchasing Managers' Index fell to 47.5 in May from 48.8 in April, marking the sharpest monthly contraction in private-sector activity since October 2023.
According to UBS, the survey results are consistent with a contraction in eurozone GDP in the second quarter of around 0.1% to 0.2%. The bank has revised its medium-term outlook, now forecasting eurozone growth of 0.8% in 2026, down from a prior projection of 1.3% before the conflict.
UBS added that a more severe disruption to oil flows would have a further negative effect on growth, potentially shaving another 50 to 60 basis points from activity and leaving economic expansion close to a standstill.
"This weaker growth backdrop should limit the ECB's ability to tighten policy as aggressively as current inflation headlines might suggest," UBS said, underlining the view that near-term rate increases are likely to be followed by a return to easing once the energy-related price shock fades.