Federal Reserve "turns left" while European Central Bank "turns right": Expectations for interest rate hikes in Europe reignite, with next week's meeting focusing on five key signals

As European Central Bank (ECB) policymakers increasingly believe that the current monetary policy is in a "good position," market sentiment has significantly reversed. Traders have begun to price in the possibility of the ECB restarting interest rate hikes in 2026, in stark contrast to the previously widespread expectations of rate cuts.

Next Thursday's ECB meeting will be a key point for the market to validate this logic. According to a report by Reuters on the 12th, although the market generally expects the ECB to keep the key interest rate unchanged at 2% for the fourth consecutive time, investors' focus has shifted from rate cuts to the future tightening path. According to a Bloomberg survey, more than 60% of economists surveyed now predict that the ECB's next interest rate adjustment will be upward, compared to only one-third holding this view previously.

Meanwhile, across the Atlantic, the Federal Reserve has just announced a 25 basis point rate cut. According to a previous article by Wall Street Insight, Goldman Sachs and several Wall Street investment banks have warned that this policy divergence—Fed easing "to the left" and ECB tightening "to the right"—is expected to show key impacts through the exchange rate market around 2026. As other central banks maintain a tightening tendency, the depreciation pressure on the dollar is becoming a market focus, which may lead to a passive appreciation of the euro, thus becoming an external variable affecting the ECB's future decisions.

Investors are closely watching the signals released at next week's meeting to find reasons to maintain their rate hike bets. Reuters points out that besides the interest rate decision, this meeting also faces five key issues regarding inflation forecasts, policy paths, geopolitical impacts, and personnel changes.

Interest Rate Decision: Maintaining the Status Quo and "Comfort Zone" Tone

The primary focus of next week's meeting will be the ECB's immediate actions and statements. The market generally expects the ECB to keep the key deposit rate unchanged at 2% for the fourth consecutive meeting. Recent data supports the policymakers' wait-and-see stance: third-quarter economic growth was 0.3%, far exceeding the ECB's September forecast, while inflation has shown stronger stickiness than expected.

ECB President Christine Lagarde has set the tone for the meeting this week by reiterating that the policy is in a "good state." According to Reuters, as the possibility of further rate cuts is ruled out, investors will closely watch whether Lagarde will provide more reasons to support the market's newly formed rate hike bets. Nordea Chief Strategist Jan von Gerich pointed out that Lagarde's task is to reflect confidence in the diminishing economic risks while avoiding overly fueling market expectations of "rate hikes imminent."

Policy Path: Shifting from Rate Cut Expectations to Rate Hike Bets

Regarding the policy path for next year and beyond, market sentiment has undergone a dramatic reversal. Just last week, rate cuts were still seen as a tail risk, but now traders believe the probability of the ECB raising rates before the end of 2026 is about 30%. This shift is mainly driven by hawkish Executive Board member Isabel Schnabel's comments, in which she expressed feeling "quite comfortable" with the market betting on the next action being a rate hike, although she also emphasized that this would not happen quickly According to a Bloomberg survey, although most members of the management committee believe that the current interest rates are appropriate, economists have adjusted their forecasts. BNP Paribas Chief European Economist Paul Hollingsworth and Jan von Gerich both predict that the European Central Bank will raise interest rates by 25 basis points in September and December 2027, respectively.

This is also the consensus among most economists: while the next step is to raise interest rates, there may be a hold until the second half of 2027. A few, including Swedbank Chief Economist Nerijus Maciulis, still warn that the current growth outlook is built on a fragile foundation and may even see another rate cut in March next year, but this is no longer the mainstream view.

Inflation Outlook: First Release of 2028 Forecast and Carbon Price Factors

Next week, the European Central Bank will release its first inflation forecast for 2028, which will be a key window for observing confidence in the medium-term inflation target. Economists expect the inflation rate to return to or slightly exceed the 2% target. If the forecast shows inflation returning to target levels, it will strengthen policymakers' argument that "the low inflation in the next two years is merely a temporary phenomenon."

It is worth noting that the EU's new carbon emissions trading system has been postponed from 2027 to 2028, which may lead to a downward revision of the inflation forecast for 2027. However, for this year and next, some economists expect inflation data to be revised upward. Schroders economist Irene Lauro believes that the new forecast may release more hawkish signals. In addition, the Bloomberg survey shows that nearly two-thirds of analysts are currently more concerned about inflation exceeding the target in the medium term rather than falling below it.

External Shocks: Dual Considerations of the Russia-Ukraine Situation and U.S. Tariffs

Geopolitical factors, particularly the situation in Ukraine and U.S. trade policy, are significant external variables facing the European Central Bank. If a peace agreement is reached between Russia and Ukraine, it would theoretically support European economic growth and lower energy prices. Schroders' Irene Lauro reminds us that while a peace agreement would be beneficial, Europe has clearly stated that it does not wish to rely on Russian gas again, so the direct economic impact may not immediately change the ECB's thinking. Regarding the plan to use frozen Russian assets to aid Ukraine, Lagarde previously stated that it was "legally and financially constrained," but her recent attitude has softened.

In contrast, U.S. policy is seen as a more direct threat. Vanguard Senior Economist Shaan Raithatha points out that Germany's fiscal stimulus and defense spending across Europe will almost be offset by the drag from increased tariffs imposed by the U.S. Bloomberg Economics' David Powell and Simona Delle Chiaie also believe that central banks may underestimate the threat posed by U.S. tariffs to the region's economy, which constitutes a downside risk to future policy expectations.

Personnel Changes: The Power Dynamics Following the Restructuring of the Executive Committee

The European Central Bank has initiated a two-year restructuring process for its Executive Board, which constitutes a long-term institutional suspense. This process will replace most of the Executive Board members and will begin early next year with Vice President Luis de Guindos. Currently, many smaller countries have joined the competition, suggesting that small nations from Eastern Europe may gain a seat for the first time.

Nevertheless, the market generally believes that this process will not have a substantial impact on the ECB's policies, as the three core positions (including the presidency) are still likely to be dominated by large economies. Jens Eisenschmidt, Chief European Economist at Morgan Stanley, pointed out that Lagarde has given the Governing Council a stronger voice than in the past and has played more of a mediator role among her peers. The future presidential candidates are expected to continue this consensus-oriented approach, with the market's focus more on personnel changes at the Federal Reserve rather than the ECB's internal restructuring