ECB may hike rates again despite weak growth - BofA By Investing.com

Bank of America says the ECB’s strong emphasis on upside inflation risks could keep policymakers biased toward more rate hikes, with the June projections consistent with 2 to 3 additional increases in the current cycle. The bank expects one more 25 bp hike in July, though weaker oil prices could delay it to September or prompt a pause. ECB balance-sheet runoff remains significant, with assets falling from a peak of €8.3 trillion in 2022 to about €6.3 trillion by end-2025, tightening liquidity conditions.

Analysis

The market is likely still underpricing the ECB’s willingness to keep a restrictive bias even if growth softens, which matters more for front-end rate volatility than for the absolute level of rates. The second-order effect is that the policy regime stays “higher for longer” until inflation is clearly beaten, which supports a persistent premium in Euribor and short-dated sovereign bills while keeping duration rallies tactical rather than durable.

The bigger overlooked channel is balance-sheet tightening. As excess liquidity drains, the marginal buyer of peripheral paper weakens and money-market rates become more sensitive to collateral scarcity and funding facility usage; that is usually when stress shows up first in bank funding spreads, not in headline policy rates. Banks with heavier reliance on wholesale funding and weaker deposit franchises are the most exposed if the ECB’s passive QT keeps pulling liquidity out over the next 6-18 months.

For equities, this is a mixed-to-negative setup for rate-sensitive sectors and levered domestic lenders, but not uniformly bearish for banks. Higher-for-longer policy can protect net interest margins near term, yet the liquidity withdrawal eventually caps loan growth and raises deposit beta pressure, so the trade is less about beta to rates and more about funding quality and asset-liability mix. The contrarian point is that a delayed hike or brief pause would likely be read as dovish by a crowded market, but unless inflation momentum rolls over decisively, that would probably be a timing shift rather than a policy pivot.

The most actionable setup is to position for volatility compression in the very front end, but not for a sustained bull-flattening until the ECB signals comfort with sub-target inflation. In practice, that favors selective short duration in euro rates and cautious relative-value positioning within European banks, where funding-sensitive names should underperform if money-market conditions tighten faster than consensus expects.

Key Decisions for Investors

• Short 2Y Bund futures / receive less duration: use any dovish ECB-driven rally to fade front-end duration over the next 1-3 months; target is a re-pricing back toward a higher terminal-rate path if inflation prints remain sticky.
• Buy EURIBOR 6M cap structures or payer swaptions into the next ECB meeting: limited premium outlay for upside if the July hike is delivered or delayed hawkishly; best risk/reward when markets are pricing a pause.
• Relative value: long large deposit-franchise euro banks vs short wholesale-funded lenders over 3-6 months; funding-sensitive names should underperform as excess liquidity falls and ECB operations matter more.
• Underweight European domestic cyclicals and rate-sensitive real estate for the next 6-12 months; they are most exposed to a higher-for-longer discount rate without the offset of strong nominal growth.
• If ECB rhetoric shifts to explicit QT concern, cover short-duration trades quickly and rotate into beneficiaries of steeper money-market curves (cash-rich banks, short-dated fixed-income carry).