ECB survey adds fuel to rate hike prospects: inflation expectations rise across the board, all above the 2% target.

The ECB's monthly survey released on Friday showed that euro-area households' inflation expectations rose across the board in August adding further support to tightening bets that are already gaining momentum after the second rate hike on September 10. The median one-year inflation expectation rose to 3.0% from 2.9% in July, the three-year from 2.7% to 2.9%, and the five-year from 2.4% to 2.5%. The three-year gauge carries greater reference value for monetary policy making. All three horizons sit above the ECB's 2% target meaning that even looking only at households' judgment, "inflation returning to target" is not genuinely believed within the visible time frame. The data support the market shift seen this month. The ECB last week raised the deposit facility rate by 25 basis points to 2.50%, its second hike since the outbreak of the Iran war and its second this year, with the main refinancing rate and marginal lending rate adjusted in tandem to 2.65% and 2.90%. The details of the survey are more telling than the three median figures. According to the ECB's announcement, households' expectations for nominal income growth over the next 12 months were unchanged at 1.0%, while expectations for nominal spending growth over the next 12 months were unchanged at 3.6% with income expectations stuck at 1.0% and spending expectations at 3.6%, the gap means households do not believe real purchasing power will improve. Over the same period, the median perceived inflation rate over the past 12 months was unchanged at 3.5%, still significantly above the actual reading; uncertainty about inflation expectations, though down from July, remained above levels seen before the Middle East conflict broke out. The breakdown also reveals a combination of "rising inflation, labor market not deteriorating": economic growth expectations for the next 12 months were unchanged at -1.2%, meaning households still expect the 21-nation economy to contract over the coming year; but the unemployment rate expectation 12 months out fell to 11.0% from 11.2% in July, only slightly above the perceived current unemployment rate of 10.5%, which the ECB interprets as "labor market prospects broadly stable." Households in the lowest income quintile continued to report higher inflation perceptions and expectations than the highest income group. The fieldwork for this survey was conducted from August 6 to 24, covering about 19,000 adult consumers across 11 euro-area countries; results for the September round are scheduled for release on October 23. In the ECB's policy reaction function, inflation expectations are not decorative. In its statement after the September decision, it made clear that policymakers are studying expectations closely because expectations shape future wage negotiations and firms' pricing behavior; the three-year gauge is particularly valued precisely because it is closer to the length of the wage-contract pricing cycle. And the ECB's own projections already show how long the "last mile" is. According to its latest projections released on September 10, the 2026 inflation forecast was kept at 3.0%, while 2027 and 2028 were revised up to 2.5% and 2.1% respectively; growth forecasts were revised higher, with real GDP growth projected at 0.9%, 1.4% and 1.5% for 2026 to 2028. By that reckoning, the point at which inflation returns to the 2% target has been pushed back to around the end of 2027. Economists and the market have clearly diverged on where rates will peak. According to the latest survey, most economists expect the ECB to hold steady at its late-October meeting, then raise rates by another 25 basis points to 2.75% at its final meeting of the year in December, and view that hike as the last step of this tightening cycle; that judgment marks a clear hawkish shift from the previous survey round previously most analysts thought the September hike would be the endpoint. Interest rate markets are pricing something more aggressive. The rate curve implies the deposit facility rate will be around 2.86% by December and rise to about 3.38% by November 2027 that is, a third hike (to 3.00%) is fully priced in, with roughly a 50% probability assigned to a fourth (to 3.25%); investors are betting on "at least three more hikes."