Key facts
- The European Central Bank is expected to hike interest rates on Thursday.
- This would be the first rate hike by a major central bank since an energy crisis began fueling inflation in the euro zone.
- Euro zone inflation rose to 3.2% in May, with services and underlying inflation increasing.
- Traders anticipate one or two more rate hikes this year after June, primarily to signal a commitment against entrenched inflation.
- The ECB may revise inflation forecasts upward and growth forecasts downward in its upcoming projections.
The European Central Bank is widely expected to implement an interest rate hike on Thursday, marking a significant move as it becomes the first major central bank to tighten policy since an energy crisis triggered by geopolitical events began to fuel inflationary pressures across the euro zone.
Policymakers are navigating a challenging environment, as the euro zone's economy is weaker than it was during the previous energy crisis in 2022. The ECB faces the dual task of containing rising prices without worsening the economic growth slowdown already underway due to higher energy costs.
Markets are largely anticipating a rate hike in June, with even dovish policymakers like Fabio Panetta and Yannis Stournaras backing the move. However, further aggressive rate hikes are not expected. Traders anticipate one or two additional rate increases this year, primarily to reinforce the ECB's commitment to combating entrenched inflation, with a September hike seen as most likely.
Inflation in the euro zone climbed to 3.2% in May, with notable increases in services and underlying inflation excluding food and energy prices. While some economists see this as a sign of broadening price pressures, they are awaiting more detailed data, noting potential impacts from Easter and a slowdown in food inflation. Forward-looking indicators are being monitored, though selling price expectations among companies have stabilized, and only a third of large companies have indicated price increases, a lower proportion than in 2022. Consumer inflation expectations have also stabilized or decreased, remaining near the ECB's 2% target.
The ECB is likely to revise its inflation forecasts upward and its growth forecasts downward. The bank will also update its alternative scenarios, with current oil and gas prices placing the outlook between the baseline and adverse scenarios. The core inflation forecast will be a key indicator of the ECB's concern about broadening price pressures.
Regarding financial stability, the ECB currently assesses that the euro zone is not facing systemic risk from recent private credit turbulence, citing limited direct exposure among financial institutions. The bank is also focusing on cyber threats related to artificial intelligence and will urge banks to adopt proactive defense measures.
Wall Street is holding its breath after a significant chip sector selloff, with tech stocks globally falling sharply. The SOX semiconductor index plunged 10% on Friday, with Broadcom down 20% over two days and the broader Nasdaq off some 4%. Futures attempted to recover, but tech-heavy Asian markets declined and Europe's STOXX 600 slid to a two-week low.
Adding to market anxiety, Iran and Israel traded direct missile strikes over the weekend for the first time since April, causing crude oil prices to rise over 4% and intensifying rate-hike expectations. Markets now see an almost 80% chance of a hike by year-end and almost two hikes within 12 months, with Treasury yields on the rise.
U.S. President Donald Trump has been fighting multiple issues, urging against interest rate rises and calling for cuts instead. His call on Israel not to retaliate against Iranian strikes on Sunday was unheeded. The fresh fighting dampens hopes of a comprehensive peace deal that would free up oil supplies.
Equity markets are resetting amid this new information and are also bracing for the mega SpaceX IPO, expected on Friday. Analysts suggest that while the wave of IPOs expected this summer can be offset by record buybacks, there is concern about a parallel wave of equity financing by hyperscalers amid gigantic AI investment buildouts, with Alphabet announcing $80 billion of new equity sales last week and reports suggesting Meta is set to follow suit.
The U.S. economy posted a third straight month of strong job gains in May, with payrolls increasing by 172,000, more than twice what was forecast. The economy also added 93,000 more jobs in March and April than previously estimated, and the unemployment rate held at 4.3% for a third month. Employment gains averaged 188,000 jobs per month over the past three months, nearly triple the comparable figure for the same period in 2025. Concern about overheating stems from estimates that the economy needs to create between zero and 50,000 jobs a month t