ECB fuelled by uncertainty

Monetary policy decision

The Governing Council voted unanimously to raise all three key ECB interest rates by 25 bps, bringing the deposit facility rate to 2.50%, a level widely perceived to sit at the upper end of the neutral policy rate range. The accompanying statement left little doubt about what is driving the decision: persistent inflationary pressure stemming from the Middle East conflict, with prices expected to remain above target for an extended period. President Lagarde added important colour during the press conference, clarifying that inflation is unlikely to return to target before the second half of 2027 a timeline that will focus minds. As one might expect given the backdrop, the ECB was candid about the uncertainty it faces with inflation risks skewed to the upside and growth risks skewed to the downside. Yet the tone was not one of alarm. The Governing Council expressed confidence that it is well positioned to navigate the turbulence, and President Lagarde stressed that the rate hike holds up robustly across all three of the ECB's economic scenarios. On forward guidance, or rather the deliberate absence of it, the message was clear: do not expect a roadmap. Policy will remain strictly data-dependent, decided meeting by meeting, and anchored to the ECB's ongoing assessment of the inflation outlook and the risks surrounding it. In that sense, the statement offered very few surprises relative to July, with only modest changes to the language overall.

Economic update

The latest ECB staff projections paint a picture of an economy that is holding up better than feared but where the inflation battle is far from won. On the inflation front, both headline and core inflation forecasts for 2027 and 2028 have been nudged higher, confirming that the path back to target will be a long one. The risks, moreover, remain skewed firmly to the upside. The Middle East conflict, potential gas supply disruptions, the prospect of a cold winter, and the creeping threat of trade fragmentation all have the potential to keep prices elevated for longer than anyone would like. On growth, the news is more encouraging. The euro area has proved more resilient than expected, with broad-based momentum across countries and sectors carrying into Q3. That resilience has prompted upward revisions to the growth outlook for 2026 and 2027. That said, the downside risks are real and cannot be dismissed: renewed energy supply disruptions, tighter global financial conditions, and a resurgence of trade tensions all remain live threats to the outlook. Looking ahead, the ECB is expected to publish an update to its alternative scenarios in the coming days something markets will be watching closely.

What comes next?

While the September decision to raise rates was described by Largarde in the press conference as a “no-brainer”, any move to increase rates from here should face a higher bar, given this will start to move rates into more restrictive territory. Faced with a highly uncertain outlook, the ECB are wise to retain full optionality around future policy decisions. The lack of resolution to the Middle East conflict has moved spot energy prices closer to the ECB’s adverse scenario. The longer this situation persists, then the more likely the ECB will be to follow up with further hikes. Market pricing for the terminal ECB rate remains highly correlated with energy prices, and will likely remain volatile until a lasting resolution to the conflict is found. With an additional 75bps of further hikes and a terminal rate of 3.25%, we feel this is looking a little overdone.

Strategy implications

The deposit rate increase takes effect on 16 September when the yield on the EUR Low Volatility Net Asset Value (LVNAV) strategy is expected to increase by around 10 basis points. This reflects higher returns on overnight reverse repo and time deposits, as well as the contribution from floating rate assets held in the strategy.

With markets remaining volatile, the strategy remains focused on active duration management. Given the steepness of the money market yield curve and market pricing that is elevated relative to our expectations, we will look for opportunities to lock in higher yields through term investments. At the same time, we will continue to size trades conservatively and average into positions over time. We also maintain exposure to floating-rate instruments, which can help hedge against faster-than-expected rate increases. Finally, we retain a high-liquidity profile, enabling us to reinvest efficiently as market rates evolve.

Source of all data: Bloomberg, European Central Bank and J.P. Morgan Asset Management, as at 10 September 2026, unless otherwise stated.