MUFG predicts ECB rate rise, flags euro downside

With a second 25-basis-point increase already fully discounted, MUFG believes the euro and euro-area yields will respond more to ECB guidance than to the rate decision itself, making Lagarde's press conference the main event risk this week. The bar for a hawkish surprise has been lifted significantly by the summer repricing, which now sees markets pricing roughly 75bp of further tightening by mid-2026. MUFG therefore views the larger risk as tilted toward disappointment if Lagarde does not strongly signal another hike before year-end, a situation that could put mild pressure on the euro.

Short-term EUR/USD direction will likely be driven more by dollar-side developments, MUFG says, with its near-term fundamentals pointing to a level around the low end of the recent 1.1400-1.1800 range. German state elections and climbing natural gas prices as winter approaches round out the downside risks to watch beyond this week's meeting.

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Previously published:

• Euro-zone second-quarter GDP accelerated to 0.6% with help from trade

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The rate decision itself is a foregone conclusion, MUFG notes; the euro's move will depend on what Lagarde indicates about the next increase.

Summary:

• MUFG expects the ECB to deliver its second 25bp hike since the US-Iran conflict began at the meeting on September 9-10 in Berlin, hosted by the Deutsche Bundesbank
• The increase is already fully priced, so MUFG expects the euro and euro-area rates to react more to updated policy guidance than the decision
• Markets now price roughly 75bp of additional ECB tightening by mid-2026, up from a more dovish stance earlier in the summer, partly driven by a renewed surge in natural gas prices since the conflict started
• Euro-zone growth rose to 0.4% quarter-on-quarter in Q2, with business confidence surveys fully recovering from post-conflict declines
• MUFG keeps its own forecast for one final hike, taking the policy rate to 3.00% and into restrictive territory, while seeing a higher risk of a third hike if second-round inflation effects emerge
• The bank flags modest downside risk for the euro if Lagarde does not endorse market expectations for another hike before year-end, alongside German state elections and rising winter gas prices as additional risks

MUFG says the European Central Bank will deliver its second interest rate increase since the start of the US-Iran conflict at this week's meeting, scheduled for September 9-10 in Berlin and hosted by the Deutsche Bundesbank. A 25bp move is already fully priced into markets, so the reaction in the euro and euro-area rates will hinge on updated guidance rather than the decision itself.

The rates market has turned notably more hawkish over the summer, MUFG notes, supported by a renewed surge in natural gas prices to fresh highs since the conflict began and a euro-zone economy that has been more resilient than expected. Growth accelerated to 0.4% quarter-on-quarter in the second quarter, and business confidence surveys have fully reversed the declines seen immediately after the conflict. Markets now price close to 75bp of additional tightening by mid-2026, a repricing that MUFG says raises the bar considerably for the ECB to deliver a hawkish surprise this week.

That repricing works in two directions for the euro. MUFG's own base case is for one final hike, bringing the key rate to 3.00% and into territory ECB Chief Economist Philip Lane has suggested might be restrictive. The bank is doubtful that a third hike will follow, given limited evidence of significant second-round inflation effects so far. The bigger risk, MUFG argues, is that the ECB falls short of current market expectations, and the euro could weaken modestly if President Lagarde does not clearly endorse another hike before year-end.

Nevertheless, MUFG sees near-term EUR/USD direction being driven more by dollar-side developments than by the ECB itself, with short-term fundamentals pointing to a level near the lower end of the recent 1.1400 to 1.1800 range. Beyond this week, the bank flags rising European natural gas prices heading into winter and upcoming German state elections, including a closely watched vote in Saxony-Anhalt, as additional downside risks for the currency.

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A major week for the EU and the ECB is ahead.