ECB preview: higher-for-longer risk is back 

Lale Akoner, eToro global market strategist, says:“The ECB looks set to raise rates by 25bps this week, but investors will be more focused on what comes next. We expect the Bank’s updated forecasts to keep the door open to further hikes, with inflation still likely to sit above target even after tighter policy.

“Energy is the key risk, but it is not the only one. Higher oil and gas prices could feed into wider price pressure if consumers start to expect inflation to stay higher, workers push for higher wages, and companies pass on rising costs. That is the ECB’s main concern, a short-term energy shock becoming a longer-lasting inflation problem.

“For markets, this brings back the risk of “higher for longer” rates in Europe. This could weigh on equity valuations, especially in growth sectors where share prices are more sensitive to higher borrowing costs. After a strong run for European equities, with the STOXX Europe 600 up around 6% over the past six months, a more hawkish ECB could clip the wings of Europe’s growth names.

“The impact will not be the same across the market, with banks potentially benefitting from higher rates, while cash and money-market funds may remain attractive for investors looking for income with lower volatility. More defensive areas of the market, including dividend-paying stocks, may also hold up better than highly valued growth names or companies with high debt levels.

“The key question is whether energy prices stay elevated because of Iran and Hormuz uncertainty, and if they do, the ECB may have less room to pause, even if growth weakens. A September hike is not guaranteed, but it is firmly back on the table if inflation expectations keep rising or energy prices fail to cool.”