The European Central Bank is widely anticipated to raise its key interest rate on Thursday, yet market participants remain split on the trajectory of monetary policy following the move. According to LSEG data, traders are pricing in a 100% probability of at least a 25-basis-point increase.
Christine Lagarde, president of the ECB, indicated after the U.S.-Iran conflict began that the bank would adopt a meeting-by-meeting strategy for monetary policy. This upcoming September decision follows recent data revealing that eurozone inflation reached 3.3% in August, with energy costs surging by 14.3%.
As a net energy importer, the eurozone has seen inflation consistently exceed the ECB’s 2% target since hostilities in the Middle East threatened commodity transit through the Strait of Hormuz, driving oil prices to spike and remain volatile. Consequently, government borrowing costs have climbed sharply, with European bond yields touching multi-decade highs as investors anticipate higher inflation and further rate hikes.
Felix Feather, an economist at Aberdeen, described the forthcoming rate increase as “all but certain” in a Wednesday analysis. He suggested the critical question is whether the ECB’s messaging signals the beginning of a prolonged tightening cycle. “The tone is likely to be hawkish,” Feather stated, noting that the eurozone economy has shown greater resilience than forecasted, while persistent high energy prices and elevated wage trackers keep policymakers focused on upside inflation risks.
The ECB previously raised rates in June for the first time since 2023, bringing the key rate to 2.25%. It became the first major central bank to hike rates in response to the war. At that time, Lagarde highlighted upside inflation risks alongside downside growth risks, emphasizing that the bank was not pre-committing to a specific rate path. The subsequent meeting saw rates held steady, with the Governing Council stating it was closely monitoring the intensity and duration of the energy shock.
Is everyone ignoring the growth risks here? Hiking rates while the economy shows resilience might be premature if inflation was already cooling.
Energy prices spiking 14.3% is brutal. Lagarde’s meeting-by-meeting approach seems like the only way to keep control of this volatile situation.
With bond yields at multi-decade highs, I wonder if the ECB is afraid to push too hard and crush the recovery entirely.