Economists expect the European Central Bank to raise interest rates next week but halt further increases, a more dovish outlook than what financial markets are pricing in. According to a Bloomberg survey, the deposit rate is set to climb by a quarter-point to 2.5 percent, a move traders are currently betting will be followed by two or three additional hikes by mid-next year. Energy markets create a policy dilemma. Risks to the economy are mounting as renewed fighting in the Middle East sends oil prices back toward US$100 a barrel and natural gas surges to 2023 levels.
The ECB faces a difficult task in calibrating monetary policy against these headwinds. While inflation sits at a three-year high and shows no sign of becoming entrenched, the prospect of persistent energy disruptions could force a more aggressive policy response than the current consensus suggests. The waterway is “the swing factor for the ECB’s future decisions, because a prolonged disruption would turn an energy-price shock into a broader inflation problem,” said Dennis Shen, a lecturer at TU Berlin’s International School of Management. The central bank can likely look through a temporary energy shock, but a sustained blockade would fundamentally change the inflation outlook and force the bank’s hand.
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Despite the tension, the eurozone economy has shown surprising resilience. Output grew more than anticipated in the second quarter, and business surveys point to solid momentum. This economic strength, combined with the expectation that inflation expectations remain anchored, gives policymakers room to pause after the upcoming meeting. Most respondents to the survey do not see evidence that businesses or consumers are bracing for stronger price pressures. While the majority is only mildly concerned about knock-on effects, particularly in wages, a small but influential group of policymakers disagrees. Executive Board member Isabel Schnabel said it is “critical” to prevent second-round effects early, noting that it will be “much clearer” in the coming months if such effects have materialized.
This divergence creates a split among the council. Lithuania’s Gediminas Simkus argued that a hike next week “isn’t going to be enough,” while Bulgaria’s Dimitar Radev referred to both September and December as “live” meetings where borrowing costs could be lifted. Others, like Ulrike Kastens of DWS International, believe the bank is “unlikely to signal any further interest-rate increases in the coming months,” though they caution that risks remain skewed to the upside. Achieving such an outcome hinges on how the situation in the Middle East evolves. The US and Iran are back to fighting over control of the Strait of Hormuz, threatening to extend a war that’s already lasted half a year. The waterway “has become the swing factor for the ECB’s future decisions, because a prolonged disruption would turn an energy-price shock into a broader inflation problem,” said Dennis Shen, a lecturer at TU Berlin’s International School of Management. “The ECB can look through a temporary energy shock; it cannot afford to look through a persistent one.” BLOOMBERG