The European Central Bank (ECB) is transitioning back to normal monetary policy, but challenges persist. Policymaker Francois Villeroy de Galhau states that in abnormal times, the journey may not end with normalisation. The ECB will closely monitor potential energy price spillovers and adapt to dynamics that might push inflation off target.

Current inflation expectations do not indicate a risk of a lasting spillover. A 10% appreciation of the euro could offset the inflation impact of a €10 rise in oil prices. The ECB remains alert and agile for future meetings. The next monetary policy move may lean towards accommodation, barring major external shocks.

The Summer Pause

Through the summer, the ECB plans to pause and consider various factors influencing their decisions. While trade and geopolitical risks are present, they are seen as temporary issues. These are not expected to be large concerns for the ECB in the broader picture.

What this article lays out, in plain terms, is that policymakers at the European Central Bank are slowly moving away from the emergency settings they introduced in recent years. Rates that were slashed, purchases that ran hot — all of that is beginning to wind down. Still, as Villeroy pointed out, the path back isn’t set in stone. Past disruptions have lasted longer than predicted, and something that seems temporary can still impact inflation or currency values if it nudges expectations out of alignment.

We notice two things of interest. First, the euro’s strength has emerged as a tool in itself. If the single currency gains about 10% relative to others, it cancels out the kind of oil price spike that would otherwise fuel higher consumer prices. That bit of arithmetic may be why the central bank feels less alarmed about energy-driven inflation. Second, actual expectations around inflation remain well anchored. There’s no sign, at least for now, that workers, companies or consumers are changing their assumptions about where prices are heading over the longer term.

With this in mind, we should not assume that interest rate hikes are nailed on for the rest of the year. Quite the opposite — unless there is a fresh surprise from outside the continent, the central bank may lean slightly towards easing policy next. This does not mean cutting rates straight away but rather staying flexible. Monitoring, pausing, and reviewing data now take priority. The summer months are more about breathing room than bold changes.

Market Volatility And Risk Management

For those of us tracking volatility or price movements in the short term, it’s important to remember that this kind of pause often leads to tighter trading ranges. Spreads may narrow across euro-linked assets if there’s no decisive policy shift, especially as governance reassures that inflation risk from trade or global conflict isn’t yet feeding through in a lasting way. Recent tensions — commercial spats or regional security challenges — haven’t dislodged conclusions around inflation targets.

If looking to position around rates in eurozone products, timing becomes sensitive. The summer window often sees thinner volumes, so any sizeable data print from inflation updates, wage growth, or consumption figures might break the current calm. That may affect implied rates and short-end volatility. Events we would typically brush off can spike reactions in quieter months.

It’s worth viewing the ECB’s caution not as uncertainty but as a form of control. They seem more determined to avoid steering markets into any false expectations. With that in mind, keeping an eye on updates from Governing Council members, particularly their tone, becomes more relevant than last meeting’s minutes or older projections.

We interpret this stance as quietly dovish without the labels. For those analysing term structures or calendar spreads, that could tilt probabilities toward a flattening in the curve, assuming no major surprises from energy markets. Short-dated rates may remain pinned, but the far end could shift if inflation surprises on the downside in the third quarter.

In positioning for risk, we argue that contracts expiring near the next ECB meeting should reflect limited movement unless supply-side news emerges. Caution around those dates makes sense, but fading abrupt reactions may offer more opportunities than chasing them.

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