LONDON, March 19 (Reuters) - Investors were sticking with bets for rate hikes in Europe on Thursday, ahead of European Central Bank and Bank of England policy decisions, with rate cut hopes dashed as the U.S.-Israeli war with Iran boots energy prices and stokes inflation fears.
The Federal Reserve on Wednesday held interest rates steady, but forecast higher inflation this year than it had previously due to surging energy prices, clouding the rate outlook.
The Swiss and Swedish central banks both kept
rates on hold on Thursday.
Oil prices are up over 50% since the start of the year and investors expect major central banks will be more responsive to higher energy prices than they have in the past, especially with the early 2020s inflationary shock fresh in the memory.
"Overall, I expect (central banks) to be more hawkish just because they have an inflation shock that's working its way through the system," said Franklin Templeton's head of European fixed income David Zahn.
"Our overall view is that this is definitely inflationary and this means the ECB will be hiking, probably this summer."
A renewed surge in energy prices overnight has pushed money market traders to price in over 55 basis points (bps) of ECB tightening by year-end, implying at least two quarter-point rate hikes.
The first rate hike is fully priced in by June. Prior to the conflict, investors had been pricing a small chance of a rate cut this year.
Some had expected the BoE to lower rates this week, before the war upended those bets. Markets now bet that the BoE will hike rates at least once in 2026.
The hawkish global repricing has pushed up bond yields sharply, with the German and Italian economies particularly sensitive to rising energy costs.
Germany's two-year bond yield, sensitive to changes in rate expectations, has jumped 50 basis points this month to its highest level since August 2024.
Britain's two-year yield rose 17 bps on Thursday to 4.282%, its highest level in almost a year.
The Reserve Bank of Australia raised its rate on Tuesday, warning of a "material" risk to inflation. It was the first major central bank to announce policy since the start of the Middle East conflict.
The Bank of Japan held rates steady on Thursday but warned of the impact rising oil could have on prices.
(Reporting by Samuel Indyk and Yoruk Bahceli; editing by Dhara Ranasinghe)
