Has the easing cycle ended? The market bets on Eurozone interest rates being "higher for longer"

Expectations for further interest rate cuts by the European Central Bank are rapidly cooling.

Investors are increasingly betting that the Eurozone will enter an environment of "higher for longer" interest rates, with market pricing indicating that the current easing cycle of the European Central Bank may have come to an end.

According to a Reuters report on August 14, the shift in market expectations is primarily driven by two key dynamics. First, the recent agreement on a trade deal between the U.S. and Europe has alleviated concerns about potential deflationary shocks from tariffs. Second, there is a widespread belief in the market that the significant fiscal spending growth soon to be implemented by Germany will effectively boost the economy, thereby reducing the necessity for the European Central Bank to further cut interest rates over a longer period.

As a result, several major investment banks, including Goldman Sachs, have adjusted their forecasts, believing that the current easing cycle of the European Central Bank has come to an end. Although trade risks may still pose pressure on growth and inflation, these banks believe that the European Central Bank, which recently provided a positive assessment of the Eurozone economy in its latest meeting, may maintain interest rates at 2% for the foreseeable future.

This shift in expectations has been directly reflected in the currency market. As investors increasingly anticipate that the Federal Reserve will resume interest rate cuts in September while the European Central Bank remains on hold, the euro has risen nearly 3% this month.

Fiscal Stimulus and Trade Easing Reshape Expectations

Behind the reversal of market expectations is the driving force of macroeconomic fundamentals, with Germany's fiscal expansion and the easing of transatlantic trade relations being the two core factors.

Germany approved a historic fiscal stimulus package of up to €500 billion in March this year. As the economic engine of the European Union, Germany's fiscal shift not only signifies its own fiscal expansion but also indicates the opening of the fiscal policy ceiling for the entire EU. The market has high hopes for this move, believing it will significantly boost overall economic growth in the Eurozone, with economists estimating that the package could raise Germany's GDP growth rate by about 1.5 percentage points, thereby reducing the urgency of stimulating the economy through monetary easing.

Additionally, although the recently reached U.S.-Europe trade agreement is not perfect for Europe, it successfully avoids the threat of higher tariffs, eliminating a major uncertainty that has loomed over the market for months. While this outcome may lead to a downward adjustment of GDP growth expectations for the Eurozone by about 0.5 percentage points, it has also significantly alleviated investors' concerns about tariffs potentially triggering severe deflation, providing more room for the European Central Bank to maintain current interest rate levels.

Investment Banks' Views Shift to Hawkish

With changes in the macro environment, the views of investment banks have generally shifted to a hawkish stance.

Paul Hollingsworth, head of developed markets economics at BNP Paribas, believes that the next move by the European Central Bank will be to raise interest rates in the fourth quarter of next year. He describes this move as a "recalibration within the neutral interest rate range," as the balance of data and risks is shifting from the drag of tariffs to the positive impetus brought by fiscal policy Lyn Graham-Taylor, a senior interest rate strategist at Rabobank, expressed a more cautious view: "We are more pessimistic about growth than others and have more concerns about inflation than others. However, we predict that deposit rates will not change until the end of 2027."

These views are consistent with judgments from institutions like Goldman Sachs, indicating that the European Central Bank's easing cycle has ended, and interest rates will remain stable for a longer period.

Market Indicators Signal a Shift in Interest Rate Path

Several key interest rate indicators reflecting market expectations clearly outline the shift in the interest rate path.

Forward contracts based on the Euro Short-Term Rate (ESTR) show that the market believes there is about a 60% chance of a 25 basis point rate cut in March next year, but this seems more like a cautious pricing to hedge against potential risks. Subsequently, rates are expected to regain upward momentum, with the market-implied deposit rate for December 2026 at 1.92%.

The Euro 5-year Overnight Index Swap (OIS) rate, regarded as a key barometer for the medium-term monetary policy outlook, has been trading above 2% for the past six weeks and is currently around 2.12%. This indicator can be roughly interpreted as the market's implied measure of the neutral rate.

Additionally, the Euro Interbank Offered Rate (Euribor) futures curve, which reflects the cost of interbank lending in Europe, shows a similar pattern, suggesting that rates may briefly dip in March next year before rising above 2% again before 2027