Deutsche Bank continues to project a 1.50% terminal rate for the European Central Bank’s (ECB) easing cycle but notes that the cycle may conclude earlier than anticipated. As the year progresses, focus is expected to move from short-term rate reductions to potential future tightening.

The bank has adjusted its 2025 euro area GDP growth forecast upward, from 0.5% to 0.8%, citing the economy’s resilience despite U.S. tariffs. Inflation is expected to drop below the ECB’s 2% target in 2025, suggesting room for further rate cuts, though the argument for a 1.50% terminal rate is losing strength.

2026 Outlook and Strategic Autonomy

Looking to 2026, Deutsche Bank anticipates increased European defence spending could boost strategic autonomy and “EU exceptionalism”. The ECB may begin raising rates by late 2026, with a policy rate forecast of 1.75%. The bank also increased its 2027 terminal rate call to 2.50%, due to fiscal commitments and a possibly higher neutral rate.

Geopolitical developments and structural spending changes could shape a more assertive ECB stance than current market expectations suggest. This evolving policy environment may influence future monetary decisions in the euro area.

What we’ve seen laid out here is a subtle yet meaningful recalibration of expectations around the European Central Bank’s (ECB) rate path. Deutsche Bank is no longer fully committed to the notion that there’s a long runway of cuts ahead. Instead, there’s now an implied ceiling – a suggestion that the rate-cutting narrative could lose steam sooner than markets thought even weeks ago.

By shifting its 2025 euro area growth forecast higher, the bank acknowledges that the region’s economy has held up better than feared. Despite external frictions, such as trade measures from the United States, core demand appears healthy enough to support higher GDP without swiftly pushing prices above the ECB’s mandate. Inflation is projected to come down below 2% next year, which under normal conditions would give the central bank ample reason to keep rates lower for longer. And yet, that’s precisely what’s being questioned.

When we unpack this, it’s not simply a tweak to terminal rate forecasts – it’s a recognition that the mood music in Frankfurt may be changing. It’s not just about getting to the floor with interest rates anymore, it’s about how long that floor remains in place.

Changing Fiscal Priorities

The attention being turned towards strengthening fiscal capacity within Europe, particularly through increased defence expenditures, adds another wrinkle. That kind of government spending is durable and large-scale, pointing to stronger internal demand longer term. It’s not the sort of expenditure likely to be reversed easily, and it could stoke inflationary pressure further down the road. That helps explain why the bank raised its terminal rate view for 2027 to 2.5%. There’s no ambiguity: monetary policy settings will need to reflect greater structural demand.

For those of us mapping out positioning strategies, especially within interest rate derivatives, the implications are fairly direct. The path from here may slope downward only modestly before finding a plateau – and from that plateau, there’s growing potential for an upward shift beyond 2026. Holding offsetting exposure too far down the yield curve without a reassessment could prove risky.

In our view, it’s not about chasing short-term momentum from near-term cuts, but instead understanding where policy will want to be after mid-decade. The ECB’s forward profile increasingly looks like one where flexibility will be necessary, and the central bank won’t be pinned into pushing rates ever lower just for the sake of it.

Geopolitical changes, new fiscal priorities, and a possible re-evaluation of the euro area’s neutral rate all feed into this revised outlook. The anticipation of firmer rates in the medium term should adjust how pricing risk is approached, especially when it comes to the back end.

Energy should be focused on the quieter shifts happening in the middle and further out on the curve. That’s where policy thinking is drifting. That’s also where alignment with current pricing may soon begin to fray.

Market participants can rely less on assumptions formed during the post-pandemic era. We have fresh drivers now – some imported, others homegrown – and all feeding into a less accommodative trajectory. Maintaining exposures assuming a one-way glide lower in rates past the next few quarters could misread the pace at which the ECB is preparing to re-anchor its stance.

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