Markets see a near 50-50 chance the European Central Bank will hike again in October

European stocks dropped to a two-month low on Thursday as the European Central Bank raised interest rates and warned of higher inflation due to an energy shock from the war in Iran. The Stoxx 600 fell 0.7% to 635.97 points, its lowest since July 8. Most major regional markets also declined. The ECB increased rates by 25 basis points to 2.5% in its second hike this year to prevent energy price inflation from spreading through the euro zone economy, which is highly reliant on fuel imports.

The central bank also raised its 2026 economic growth forecast to 0.9% from 0.8%, with expectations of inflation averaging 3% this year. Mark Wall, Deutsche Bank's chief European economist, noted that while inflation risks may be rising and a further December hike is likely, the ECB still needs to be cautious. ECB President Christine Lagarde said at a press conference that inflation outlook risks are to the upside and price pressures could persist above the target for an extended period, though the bank has not pre-committed to any future actions.

Germany's 10-year bond yield hit its highest level since 2011, with traders pricing in an additional 60 basis points of rate hikes by the April 2027 meeting. Oil prices surged over 3% to US$105 a barrel after a significant spike in shipping attacks spurred concerns about potential supply disruptions. Miners were the worst-performing sector, down 3.7%.

US economic data showed a hotter-than-expected Producer Price Index, which is expected to influence whether the Federal Reserve raises interest rates next week. Individual stocks saw significant declines, with Associated British Foods falling 7.9% after weak sales at its budget fashion subsidiary, Primark.