The European Central Bank spent the better part of two years cutting rates. Now, one of its most influential voices is suggesting the next move might be in the opposite direction.

Bundesbank President Joachim Nagel has warned that the ECB is increasingly likely to raise interest rates as the Iran war drives energy prices higher across Europe.

The energy price problem, again

ECB chief economist Philip Lane has echoed Nagel’s concern, stating that a global oil shock resulting from the Iran war may necessitate rate hikes to prevent energy-related inflation from bleeding into wages and broader price levels.

The ECB’s deposit rate has sat at 2% since June 2025, a level policymakers reached after months of gradual cuts designed to support a sluggish eurozone economy.

Market futures have already started adjusting. Traders are now pricing in one to two 25-basis-point rate hikes through the remainder of 2026. That’s a meaningful shift from just weeks ago, when the consensus still leaned toward rates staying flat or even drifting lower.

Caught between two bad options

The ECB itself has acknowledged a shift toward “upside risks to inflation” alongside “downside risks to growth.”

Nagel’s public comments suggest he’s firmly in the “act early” camp. The Bundesbank has historically been the inflation hawk in European monetary policy discussions, and its current president appears to be staying true to form.

The ECB’s southern European members, representing countries like Italy, Spain, and Greece, tend to be more cautious about rate increases. Their economies carry larger debt burdens, making them more sensitive to higher borrowing costs.

What this means for investors

The broader macro picture matters here. If the ECB follows through on rate hikes while the Federal Reserve holds steady or continues its own path, the resulting divergence in monetary policy creates volatility in currency markets, bond markets, and risk assets generally.

The timeline matters too. Market expectations pointing to hikes through 2026 suggest this won’t be a sudden shock but rather a slow grind higher.

One thing worth watching closely: European government bond yields. If the market starts aggressively pricing in ECB hikes, yields on German bunds and other sovereign debt will rise, creating competition for capital that might otherwise flow into riskier assets.