Global central bank policies are witnessing an unusual divergence. Investors are increasingly betting that the Eurozone could raise interest rates as early as next year, while the U.S. continues to cut, a reversal that may further weaken the already sluggish dollar.
Swap market pricing suggests the likelihood of the European Central Bank (ECB) hiking rates in 2026 now exceeds the chance of cuts. In contrast, the Federal Reserve, widely expected to cut rates at its Wednesday meeting, is projected to deliver at least two more reductions next year. Investors are also wagering on rate hikes by the Reserve Bank of Australia (RBA) and the Bank of Canada (BoC) in 2026, while the Bank of England (BoE) is anticipated to hit its rate floor by mid-year.
This policy divergence could exacerbate the dollar’s decline. The greenback has already fallen over 8% against a basket of currencies this year. The Eurozone and other major economies—traditionally associated with lower rates—are now facing a shift, partly due to the milder-than-expected impact of Trump-era trade wars on U.S. trading partners.
Pooja Kumra of TD Securities described 2026 as a potential "turning point" for the ECB, BoC, and RBA, adding, "Hawkish voices are growing louder."
**Hawkish Expectations Reshape Market Pricing** The reversal is starkly reflected in swap market data. Current pricing implies an average 10-basis-point hike in Eurozone rates by end-2026, whereas markets had priced in a 4-basis-point cut just last week.
This sentiment shift aligns with signals from policymakers and analysts. ECB Executive Board member Isabel Schnabel reportedly expressed comfort with investor bets on a 2026 rate hike. Tomasz Wieladek, Chief European Macro Strategist at T. Rowe Price, noted that global tariff shocks have been far milder than initially feared, prompting central banks worldwide to adopt a more hawkish tilt.
Kumra reiterated that 2026 could mark a "turning point" for the ECB, BoC, and RBA, emphasizing that "hawkish voices are growing louder." The shift drove global bond yields higher on Monday, with Germany’s 10-year yield jumping 7 basis points to 2.87% before retreating to 2.847%.
**Economic Data Backs Policy Split** While the Fed’s dovish path appears set—with a near-certain rate cut expected Wednesday and at least two more next year amid Trump’s pressure for lower borrowing costs—stronger-than-expected data elsewhere is undermining the case for synchronized easing:
- **Canada**: Robust November jobs data has traders pricing in a slight chance of a BoC hike in early 2026. - **Australia**: Last week’s strong household spending figures have markets assigning a non-negligible probability of an RBA February hike. - **Japan**: After Governor Ueda’s recent hints, traders now expect at least two 25-basis-point hikes by the Bank of Japan by end-2026. - **UK**: While the BoE is expected to cut rates next week from 4%, markets price only one more 25-basis-point reduction afterward. The OECD predicts the BoE’s easing cycle will pause in H1 2026.
**Dollar Faces Further Repricing** Interest rate differentials are a key driver of currency moves, with lower rates typically diminishing a currency’s appeal. Though the Eurozone and other economies still lag the U.S. in rates due to slower growth, the gap is narrowing.
ING’s Chris Turner noted that if the Fed stays dovish, overseas policy shifts could become another factor weighing on the dollar in 2026. The contrast in policy directions may deepen the greenback’s 8% annual decline against peers.
With stubborn services inflation in regions like the Eurozone and improving economic data, non-U.S. central banks have little incentive to cut further. Should the Fed remain the sole major bank cutting in 2026, a reversal in global capital flows could pose severe challenges for the dollar over the next year.
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