Investing.com — European bond yields are expected to decline next year, and the euro could recover against the U.S. dollar, as ECB President Christine Lagarde’s early departure is unlikely to alter the central bank’s monetary policy outlook, according to UBS.
Lagarde announced her resignation effective February 7, 2027, hours before the European Central Bank held interest rates unchanged amid persistent inflation pressures and rising energy costs.
UBS expects a smooth leadership transition, arguing that inflation, wages, economic growth and financing conditions will remain the primary drivers of interest rates.
The ECB has raised rates twice this year, with inflation running at roughly double its 2% target.
Although policymakers have signaled further tightening may be necessary, UBS believes the central bank will wait for clearer evidence of persistent inflation before acting.
A December rate increase remains possible, particularly if higher energy prices trigger broader inflationary pressures.
Still, UBS expects Eurozone sovereign borrowing costs to decline into 2027, despite continued volatility in French government bonds.
France’s fiscal and political challenges could push sovereign spreads wider without credible budget consolidation.
UBS said the ECB could respond to disruptive market pressures through flexible reinvestment of maturing bonds, with its unused Transmission Protection Instrument providing another option.
The bank believes markets are pricing in excessive tightening, with expectations for another 75 basis points of ECB increases appearing difficult to justify.
It favors selectively extending duration in high-quality European bonds, particularly short- and medium-term maturities, including agency, covered and investment-grade corporate debt.
Longer maturities remain less attractive amid fiscal concerns and substantial bond issuance.
For currencies, UBS maintained its bullish euro outlook, forecasting EUR/USD to recover toward 1.16 by year-end.
The bank believes the euro’s recent decline has exceeded what underlying economic fundamentals would suggest.
Still, energy prices, monetary policy differences, sovereign spreads and geopolitical developments could keep currency markets volatile.