The European Central Bank is no longer unified on whether to continue tightening policy. Rapidly falling oil prices and cooling inflation in the eurozone are diminishing the urgency for further interest rate hikes, prompting markets to reassess the rate outlook for the year.
According to reports, during the recent annual forum in Sintra, Portugal, ECB officials revealed significant disagreements over the need for additional rate hikes to bring inflation back to the 2% target. Some officials believe inflationary pressures stemming from the conflict are still transmitting through the economy and may manifest later through wages, food, and services prices.
Other officials argue that with progress in peace efforts and oil prices falling back to pre-conflict levels, severe secondary inflation effects are not necessarily inevitable. The sharp drop in eurozone inflation in June supports this view.
Markets widely expect a major policy shift at the July meeting to be highly unlikely, with maintaining the status quo being the consensus. However, as more wage data is released ahead of the September meeting, the probability of the disagreement intensifying will rise significantly.
Dovish Camp: Limited Risk of Secondary Effects, Data Supports Inflation Cooldown
Several officials have publicly expressed the view that inflation risks are moderating. Bank of Finland Governor Olli Rehn stated in an interview that he does not foresee any major secondary effects, implying limited support for further hikes.
Austrian National Bank Governor Martin Kocher noted in a separate interview that the inflation threat "has clearly diminished, at least in the short term."
Governing Council members from Slovenia and Latvia, Primoz Dolenc and Martins Kazaks, both indicated no need for action in July. Belgian National Bank Governor Pierre Wunsch suggested there might not even be a reason for another hike.
Eurozone inflation was 2.8% in June, a notable slowdown from May's 3.2% and below the median economist forecast of 3%. Core inflation, which excludes volatile items like food and energy, and the closely watched services inflation measure also eased.
This shift is largely due to oil prices falling to pre-conflict levels, significantly lower than the assumptions used in the ECB's forecasts last month. Those forecasts predicted inflation would remain above the 2% target until 2027.
Hawkish Camp: Vigilance Against Inflation Rebound
Meanwhile, hawks led by Chief Economist Philip Lane remain cautious. As a key figure proposing policy to the Governing Council, Lane emphasized officials' commitment to "not locking themselves" into a fixed rate path.
Bundesbank President Joachim Nagel echoed this, though he acknowledged the oil price drop was "indeed surprising."
Estonian central bank governor Ulo Kaasik said in an interview he believes at least one more hike is "reasonable," while Greek central bank governor Yannis Stournaras suggested in another interview that "perhaps it's better to stay where we are for a while." These statements are seen as representing the two poles of the current divide.
ECB President Lagarde: Risks Now More Balanced
ECB President Christine Lagarde acknowledged the rapidly changing situation during the Sintra forum's closing panel, which also featured Federal Reserve Chair Jay Powell.
She stated that given recent rapid developments, upside inflation risks and downside growth risks are "probably more balanced than they were a few weeks ago."
Wage Data as the Key Variable, September Meeting a Potential Turning Point
Analysts believe that while current inflationary pressures have eased, clearer judgment requires waiting for more data due to the long publication lag for wage figures. If the period of higher inflation has already pushed up wage demands, price pressures could become more entrenched and persist longer.
Bloomberg Economics Eurozone Chief Economist Simona Delle Chiaie noted that an improving economic outlook could widen the Governing Council's divisions, as the urgency for further hikes declines. She stated that while the baseline forecast still includes one final hike this year, the downside risks to that call are becoming more prominent.
As more economic data emerges before the September meeting, the debate within the ECB over the rate hike path is expected to intensify, making it a key window for observing the direction of eurozone monetary policy in the second half of the year.
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