Investors expecting too many hikes from the ECB

The euro-zone economy is likely to continue growing at around its trend rate of 1% over the next year or two. Among the largest countries, Germany, France and Italy will grow at a modest pace while Spain will continue to outperform, thanks to continued rapid immigration. Headline inflation for the euro-zone as a whole will rise to about 4% at the turn of the year and, due to the indirect effects of higher energy costs, core inflation will edge up over the next few quarters. But second-round effects on wages are likely to be trivial, so headline inflation will fall sharply next year and should be consistent with the 2% target by the end of 2027. After raising the deposit rate in December, we think the ECB is unlikely to tighten much further, if at all. And moving into the second half of next year, interest rate cuts will come back onto the agenda. In contrast to what is priced into the market, we think that in 2028, the deposit rate is most likely to be below its current level. This means that we think bond yields will fall in 2027, while spreads will remain low in most countries. The exceptions are France and Italy, where elections and shaky public finances may cause spreads to widen.