Euro rates have good reason to be nervous
The desk perceives a heightened volatility scenario for euro rates through 2027, with considerable upside risks stemming from inflation trends. Per the full note , while the baseline outlook anticipates easing inflation leading to a euro swap rate stabilization near 2.5%, unexpected inflation readings could spur rates above 4%. This nuanced understanding reflects a broader shift away from previous year forecasts, suggesting a more turbulent trajectory ahead for euro-denominated bonds.
What the desk is arguing
The desk frames this situation as a complex interplay of evolving inflation concerns and market reactions. While easing inflation pressures should ideally temper euro rates, the potential for upside surprises remains a significant risk factor in the near term, especially as the European Central Bank (ECB) aims to maintain a terminal rate around 2.5% through 2027 as a stabilizing anchor.
Supporting this view, the research cites that the market's anxiety over inflation data will likely keep investors on edge, indicating that a negative inflation print could trigger sizable market reactions reminiscent of the turbulence experienced in 2022 and 2023. Essentially, the expectation of a calm decline in rates appears overly optimistic given the current inflation landscape.
Where it sits in our coverage
Our internal consensus target for the euro stands at 1.075, within a range of 1.04 to 1.12. Firms such as jpmorgan project a target of 1.10 for March 2026, while bofa holds a contrary view with a lower target of 1.04 for the same tenor.
This view aligns with the broader consensus that sees a challenging yet gradually improving scenario for euro rates. The desk's expectation of potential spikes above 4% in the near term intersects at the upper end of this spectrum, emphasizing the heightened uncertainty in rate movements as opposed to a uniform expectation of stability.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Easing inflation expectations could lower euro rates by mid-2027, but risks of upward corrections remain pronounced.
- 02A negative inflation reading could elevate the 10-year euro swap rate significantly, above levels reached in previous years.
- 03The ECB's terminal rate projected near 2.5% reflects a strategic constraint in managing inflation while stimulating growth.
- 04Expect heightened market volatility influenced by frequent inflation data releases, with reactions hinging on new prints.
Market implications
Traders should watch for key inflation releases as they will be crucial in determining market sentiment and potential rate adjustments in Europe. A strong inflation report could trigger risk-off sentiment and challenge the stability anticipated in euro rates.
Risks to this view
Key risks to this outlook include any signs of persistent inflation that could compel the ECB to pivot towards a more aggressive tightening stance, leading to a surge in euro rates. Additionally, a broader market response to global bond supply pressures could necessitate adjustments in expected euro rate paths.
Articles Euro rates have good reason to be nervous Published 10:29 Rates Translate Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download Easing inflation fears should bring euro rates down by mid-2027, but the path lower will be bumpy. We shift our attention from oil to inflation data and expect markets to react anxiously to upside surprises. Rising bond issuance outside the US government and AI could catch markets by surprise, but that is not our base case Michiel Tukker We see substantial near-term upside risk to euro rates but a more constructive year-end outlook Last year’s outlook was all about a stabilisation of euro rates, and boy, were we wrong.
For 2027, we have no illusions of a calm ride. Our 2027 euro rates view combines substantial near-term upside risk with a more constructive year-end outlook. Ugly second-round inflation fears could push the 10-year euro swap rate above 4%, while faster disinflation could take it towards 2%.
Our baseline is that inflation pressures ease and the ECB terminal rate anchors near 2.5% by the end of 2027, although heavy global bond supply should keep long-dated rates relatively elevated. Inflation is one of many uncertainties that can trigger different rate paths Source: ING, Macrobond "> Source: ING, Macrobond For 2027, we shift our focus from oil to second-round inflation risks Oil was the big story of 2026, but in 2027 we can no longer rely on the oil price to tell us where rates will go. Even if oil fell below $80/bbl, as assumed in our baseline, swap rates would not find much immediate relief.
Instead, markets will watch each inflation reading anxiously for signs of second-round effects. We take a relatively optimistic view in our baseline, but the upside risks to rates from inflation remain material. One bad reading could be enough to spook markets and risk a repeat of 2022-23, while it would take a series of benign inflation readings to convince markets of a more dovish tilt.
We therefore see limited downside to rates in the first half of 2027. Only once there is sufficient evidence that second-round risks are limited do we turn more bullish on rates. A tail risk for rates would be rising inflation combined with an inability of the ECB to stem the increase.
Markets are pricing inflation in two years’ time (the 1Y1Y forward) at just 2.2%, suggesting strong confidence in the ECB’s ability to return inflation to target quickly. This is consistent with markets pricing in an aggressive further three ECB hikes. However, the effectiveness of monetary policy during supply shocks may be limited.
Energy prices are still far from settled, and the global geopolitical landscape remains unstable. Meanwhile, artificial intelligence investment is unlikely to respond to a few 25bp hikes when earnings growth is measured in double digits. A perceived weakening of monetary policy transmission, combined with upside inflation surprises, could push two-year euro swap rates another 100bp higher.
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