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Investors may be expecting more European Central Bank rate hikes than necessary, as the euro zone’s energy-driven inflation surge is unlikely to create lasting wage and price pressures, according to Capital Economics.
The research firm expects the ECB to raise its deposit rate by 25 basis points in December, taking it to 2.75% from 2.5%. However, it sees little justification for additional monetary tightening after that increase.
Capital Economics forecasts that ECB rate cuts could return to the agenda during the second half of 2027, with the deposit rate eventually falling to 2% in 2028. That outlook is below the interest-rate path currently priced into financial markets.
A key factor is the limited risk of significant “second-round” inflation effects, where higher energy costs lead to sustained increases in wages, corporate profits and broader prices. Capital Economics said the euro zone labour market is not especially tight, while economic demand is not significantly exceeding potential supply.
Euro zone headline inflation is expected to rise to around 4% in December before declining sharply during 2027. Core inflation, which excludes volatile components, could reach roughly 3% in the first half of next year as elevated energy costs spread indirectly through the economy. It is then forecast to move toward 2% by 2028.
“After raising the deposit rate in December, we think the ECB is unlikely to tighten much further, if at all,” Capital Economics said.
The euro zone economy is also expected to maintain relatively steady growth. Capital Economics forecasts GDP expansion of 1.0% in 2026, 1.1% in 2027 and 1.0% in 2028.
One major risk is a prolonged disruption to energy supplies through the Strait of Hormuz. Such a shock could drive inflation higher and require the ECB to keep borrowing costs elevated for longer.
Even under that scenario, Capital Economics expects weaker demand and a softer labour market to constrain wage-driven inflation, limiting the case for a more aggressive ECB tightening cycle.
