According to Reuters, members of the Governing Council of the European Central Bank (ECB) are leaning towards raising interest rates again at their September meeting to contain the inflationary impact of the war between the US and Iran, although, for the moment, they show little willingness to anticipate further subsequent hikes.
According to Link Securities, three sources familiar with the deliberations told Reuters that the ECB could raise the deposit rate from 2.25% to 2.50%, following the increase applied in June, the first in almost three years.
The final decision will be made at the meeting on 9 and 10 September, once the inflation data for August and the new economic forecasts are known. The goal is to prevent the sharp rise in energy prices caused by the conflict from being persistently passed on to the wider economy. Eurozone inflation is currently approaching 3%, while economic activity is showing greater resilience than expected.
In this context, ECB Executive Board member, German Isabel Schnabel, has toughened the message. In an interview with Bloomberg released yesterday, she stated that rates will need to continue rising, as with the current level it is unlikely that inflation will return to the 2% target in the medium term. She warned that the rising energy prices could keep inflation above the target for a prolonged period and that waiting for the pressures to be passed on to wages would leave the ECB “behind the curve.”
Assessment: the unexpected strength that the Eurozone economy is currently showing and the persistence of the conflict in the Middle East, with its inflationary implications, therefore raise the risk that the ECB will have to prolong monetary tightening and raise its main reference rates by 25 basis points at its Governing Council meeting to be held in early September.
As noted by analysts at Morgan Stanley:
THE ECB ENTERS SEPTEMBER WITH MORE UPSIDE RISKS FOR GROWTH AND INFLATION
Recent data points to upside risks for both growth and inflation, reinforcing the rate hike in September (MS's base scenario and consensus) and a hawkish message. Although the market still does not discount an aggressive subsequent cycle and the macro team continues to expect a pause in December, the ECB will hardly close the door to another hike in December if energy prices and economic activity continue to surprise to the upside.
- Inflation continues to behave well for now. The July data showed no evidence that rising energy costs are being passed on to food, goods or services. Even sensitive sectors like transport and airfares did not reflect significant inflationary pressures during the summer peak season.
- Wages are not a concern either. The ECB's wage indicators continue to point to growth around 2.5%, with no signs of a backward-looking cost spiral that would justify a source of upside in the short term.
- However, future risks are increasing. Although the oil used in the September projections will be lower than assumed in June, the strong rebound in gas offsets that effect. Furthermore, the latest energy increases may not be fully reflected in the ECB's projections, generating upside for the inflation projections for 2027.
- Growth is also surprising to the upside. After a more volatile first half of the year than expected, Eurozone GDP grew a solid +0.4% quarter-on-quarter in Q2, dispelling fears of a slowdown and leaving few downside risks for the ECB's growth forecasts.
- Prospects for late 2026 and 2027 could even improve. Global manufacturing activity continues to recover, and Europe is finally starting to benefit from that cycle, pointing to stronger-than-expected growth.
- The main counterbalancing force is the tightening of financial conditions. The rise in bond yields during the summer already represents some additional restriction for the economy.
