Inflation Middle East Conflict Rising Rates Fixed Income Blog

Can the Eurozone Tolerate Higher Rates for Long?

Jun 17, 2026
3 min read

The market is pricing in higher euro rates through 2031. But can the region’s economy take them?

As expected, the European Central Bank (ECB) raised its three key interest rates by 25 basis points (bps) on June 11, responding to the energy shock from the Iran war. Inflation was revised higher for 2026 and 2027, and it is expected to fall to target in 2028. Although we expect one more hike, the timing is uncertain as the ECB is keeping all options open—including the possibility of not raising rates again.

Should the ECB pause in July and a resolution to the conflict is reached, we think it would be harder to justify further rate hikes. In any case, two hikes seem consistent with the ECB’s price-stability mandate and would be easy to reverse swiftly once inflation normalizes.

The Euro Area Economy Has Weakened

While there’s a chance of further hikes beyond our forecast, we think more policy tightening could be risky given the current macro environment. Today’s euro-area economy is weaker than in February 2022—when Russia’s invasion of Ukraine triggered the last energy shock—and wage growth and job vacancies have been trending down (Display). Euro-area inflation was undershooting the target before the Iran war started, in contrast to the 5.6% inflation rate that prevailed before the Ukraine invasion. 

Wage Pressures Were Easing Before the Iran War
European Central Bank Wage Measures (Quarterly Percent)
Line chart of eurozone wage measures since 2013 with sharp spike around 2020 and elevated but moderating trends into 2026.

Past performance does not guarantee future results.
As of April 30, 2026 (ECB wage tracker); January 31, 2026  (compensation of employees and negotiated wages)
Source: European Central Bank (ECB)

While European natural gas prices have risen substantially, they’re still materially cheaper than during the Ukraine crisis period (Display), and medium-term inflation expectations have remained anchored so far. That’s an important gauge of both the ECB’s credibility and the absence of severe second-round inflationary effects at this stage.

Oil Prices Have Surged, but European Natural Gas Prices Are More Muted
Brent Oil (USD Per Barrel) and TTF Gas (EUR/MWh)
Two lines show oil prices and European natural gas prices since 2021, highlighting trends after Russia invaded Ukraine and since the war in Iran began in 2026

Past performance does not guarantee future results.
As of June 9, 2026
Source: Bloomberg

In addition, considering euro-area governments’ stretched finances, fiscal support will likely be limited both in size and duration, and therefore unlikely to stoke inflation. All these factors put the current inflationary environment in context (Display), arguing for a smaller hiking cycle, in our view.

The Current Inflation Shock Is Less Severe than the Ukraine Invasion’s
Euro-Area Inflation Measures (Percent)
Bar chart compares higher 2022 inflation with lower 2026 levels across categories, indicating easing price pressures

For illustrative purposes only.
The average numbers represent the average realized 12-month headline inflation rate in 2022 compared with the average 12-month headline inflation rate that AB expects for 2026. 
As of June 9, 2026
Source: Eurostat and AllianceBernstein (AB)

Consequently, we think euro policy rates will need to be cut back to neutral in 2027, or lower if the euro-area economy continues to underperform while inflation normalizes.

By contrast, the market is pricing a rising interest-rate trajectory, with euro rates a full 60 bps higher in five years’ time (Display). But we don’t believe the region’s economy can withstand even moderately restrictive rates for an extended period, and we don’t think this inflationary shock requires them.

The Market Expects Rates to Stay Elevated for Longer
Comparison of AB vs. Market Forecasts (Percent)
Lines show rate expectations rising short term but diverging longer term, with the market’s pricing climbing and the AB forecast flattening

For illustrative purposes only.
As of June 9, 2026
Source: Bloomberg

The ECB’s rate hikes could prove counterproductive, considering the fragility of the euro-area economy and the expected limited pass-through effects from higher energy prices. But unless the Iran war takes a turn for the worse, if the market’s expectations for rate hikes play out, it could be even more counterproductive.

The views expressed herein do not constitute research, investment advice or trade recommendations, do not necessarily represent the views of all AB portfolio-management teams and are subject to change over time.

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