ECB rate hikes in response to the transmission of THE energy shock
As it had almost pre-announced in April, the ECB raised its rates for the first time since September 2023: +25 basis points, bringing the deposit rate to 2.25%. This decision is driven by the impact of the energy shock - linked to the conflict in the Middle East - on inflation. Inflation accelerated to 3.2% in May due to the sharp rise in energy prices (11.9% year-on-year) and their spillover to the rest of the economy, as evidenced by the increase in services prices to 3.5% (from 3% in April).
During the press conference, Christine Lagarde left the door open to a further increase in key interest rates. The prolongation of the conflict and the persistence of high oil prices have led the ECB to significantly revise its inflation outlook upwards (3% on average in 2026 and 2.3% in 2027), as well as core inflation (2.5% in both years). Growth prospects have only been marginally revised downwards. This confirms our expectation of a further 25bp rate hike in September to firmly anchor inflation expectations and support a return to the 2% target.
The framework agreement announced between the United States and Iran over the weekend does not alter our baseline scenario. Even assuming a full reopening of the Strait of Hormuz (which is not guaranteed), oil prices would remain above pre-conflict levels, creating a risk of second-round effects that the ECB will need to contain.
Rate Hikes: Supporting Banks’ Margins
The banking sector, representing over half of our money market fund investments, exhibits robust fundamentals. Banks are thus well-positioned to navigate an uncertain macroeconomic and geopolitical environment.
The ECB's rate hike should support banks' net interest margins, particularly for those combining variable-rate loans with sustained loan volume growth.
Although rising rates and current uncertain operating environment could weigh on asset quality, banking fundamentals, anchored on a very strong base, should remain sound.
First-quarter results confirm this robustness: the non-performing loan ratio in the Eurozone remains low (2.2%, source: ECB), and capital ratios (average CET1 of 16.2%) and liquidity ratios (average LCR at 158%) show high levels.
Ostrum AM Sustainability & Credit Research supports investment decisions by expressing a fundamental view on banking issuers, complemented by sector analysis. The team of 22 sector expert analysts conducts proprietary fundamental analysis, systematically integrating ESG factors. This rigorous process enables us to generate investment ideas, identify entry/exit points, and offer an informed and forward-looking perspective, essential for banks and applicable across all the other sectors we cover.
Money Market Funds: An Investment in Uncertain Times
The increase in ECB rates is a supportive factor for money market funds.
On one hand, the banking sector effectively benefits from a higher interest rate environment. This dynamic mechanically benefits money market funds, in which banks are heavily represented. Indeed, banks are among the largest issuers of commercial papers, meeting the strict credit quality criteria of money market funds. They also display a satisfactory level of liquidity in the secondary market.
On the other hand, due to their structure, money market funds distinguish themselves during periods of rising interest rates, which fully validates their conservative nature. Their low duration, or sensitivity to interest rates, allows them to closely follow €STR changes and neutralise rate shocks, thus limiting the volatility of their net asset values. This characteristic is achieved through investment strategies focused on short-dated instruments or those incorporating variable rate indexations, complemented by the use of interest rate swaps for hedging purposes. This responsiveness, coupled with strict liquidity ratios, positions money market investment as a prudent allocation in times of interest rate fluctuations and macroeconomic uncertainties.
