Key Takeaways
- Following the Iran war ceasefire, markets are predicting roughly two ECB rate hikes in 2026, down from more than three earlier in April.
- Before the war started, the ECB was seen as keeping interest rates steady this year.
- The outlook for oil prices, inflation, and economic growth remains uncertain amid concerns about the ceasefire’s durability.
The ceasefire in the Iran war may have provided some relief from soaring oil prices, but perhaps not from European Central Bank interest rate increases this year.
Before the war, the ECB had been expected to keep rates steady in 2026. However, the war-driven surge in energy prices revived inflation concerns, leading financial markets to quickly shift to expect as many as three rate hikes this year.
With the ceasefire, the interest rate swap markets—derivative markets where investors trade expectations for future interest rates—have repriced significantly, with investors now predicting roughly two hikes. The implied rate path has flattened notably, and the terminal rate—the final policy rate after the ECB has completed its rate-hiking cycle—has fallen to around 2.5% from 2.7%. The deposit rate currently stands at 2.0%.
Michael Field, Morningstar’s chief European markets strategist, cautions that the economic impact could persist well beyond any ceasefire. “The pivot from potentially cutting interest rates further in 2026 to instead increasing rates lies squarely on the Iran war,” he says. “The implications of the elevated oil price on inflation and the global economy cannot be overstated. With equity markets pricing in cuts earlier this year, and certain sectors of the economy dependent on said cuts, even if the war ends tomorrow, we will be dealing with the fallout for the rest of the year.”
The Ceasefire’s Impact on Rate Expectations
After intensifying military threats and rhetoric, the United States and Iran agreed to a two-week ceasefire Tuesday night. Markets responded immediately. Brent crude prices dropped roughly 13% to around USD 95 per barrel, easing concerns about an energy-driven inflation shock. But oil prices rebounded and equity markets softened on Thursday as optimism faded, with Washington and Tehran accusing each other of violating parts of the deal, underscoring the ceasefire’s fragility.
The one-year euro inflation swap fell by a sharp 0.38 percentage points to 3.11%. The swap reflects market expectations for inflation over the next 12 months, and the sharp drop suggests investors expect significantly lower inflation ahead. “In turn, that saw investors price out the likelihood of rapid rate hikes, with the probability of an ECB hike this month down from 68% before the ceasefire announcement to 32% by yesterday’s close, and a further decline to 29% this morning,” explains Jim Reid, global head of macro research and thematic strategy at Deutsche Bank.
The probability of a rate hike in the coming months has also dropped sharply, with markets pushing back expectations for tightening in April and June. An initial 0.25-percentage-point hike is now priced for the ECB’s June meeting, followed by another move of the same magnitude in the third quarter, according to swap market data.
That reduction fed directly into bond markets. German bund yields—the euro area benchmark—moved sharply lower. The 10-year yield fell to 2.94%, while the more policy-sensitive two-year yield declined to 2.50%.
“That backdrop of lower energy prices meant that inflation fears eased dramatically, which in turn led to a dovish repricing of central banks, especially in Europe,” says Reid. “The repricing marks a reversal of sentiment earlier in the week, when escalating tensions in the Middle East—including threats to shipping routes and energy infrastructure—had pushed oil prices higher and triggered a hawkish shift in rate expectations,” he wrote in a research note on April 9.
ECB Policy Rates
Since June 11, 2025, the three ECB key interest rates have been:
- Deposit rate: 2.00%
- Main refinancing rate: 2.15%
- Marginal lending facility: 2.40%
Eurozone Inflation Risks Skewed to the Upside
Policymakers remain alert to the risk of higher inflation. According to a Bloomberg report, ECB governing council member Olaf Sleijpen warned that sustained energy disruptions could still feed into broader price pressures. “Persistently high oil prices will ultimately feed through to the prices of other products, and thus also to wage formation, which could amplify inflationary effects,” he said. “In that case, the ECB will naturally intervene to keep inflation around 2% in the medium term.” He added that the longer the conflict drags on, the greater the potential impact on both growth and inflation, highlighting the precarious nature of the current market calm.
ECB staff revised their inflation forecasts in March. They now expect headline inflation to average:
- 2.6% in 2026 (up from 1.9%)
- 2.0% in 2027 (up from 1.8%)
- 2.1% in 2028 (up from 2.0%)
For core inflation, which excludes energy and food, ECB staff project an average of 2.3% in 2026, 2.2% in 2027, and 2.1% in 2028. This compares with December projections of 2.2% in 2026, 1.9% in 2027, and 2.0% in 2028.
