With the European Central Bank having raised interest rates by 25 basis points in June, the outcome of tonight's monetary policy meeting is almost a foregone conclusion: the ECB is set to press pause on rate hikes, holding the deposit rate at 2.25%.
However, what will truly capture market attention is not the decision to stand pat, but rather the extent to which the ECB leaves the door open for further policy tightening in September and beyond.
As geopolitical tensions in the Middle East flare up again and oil prices climb back above $90 per barrel, market expectations for additional tightening measures are heating up once more.
A Pause with Options Preserved
Since last month's rate hike and the accompanying signal that further action was possible, a series of favorable data points from the Eurozone—including lower-than-expected inflation, moderate wage growth, and receding price expectations—have significantly reduced the urgency for consecutive rate increases.
However, renewed conflict between the US and Iran is rapidly rewriting the economic script.
Oxford Economics economist Oliver Rakau has characterized this decision as a "hawkish pause," noting that current data slightly favors further policy tightening, which aligns broadly with the ECB's June projections and market pricing.
Financial markets have already priced in future moves.
Traders anticipate the ECB will complete the remaining rate hikes by February next year at the latest, with a 60% probability of another hike by mid-next year.
According to estimates by Morgan Stanley economist Jens Eisenschmidt, a deposit rate of 2.5% would constitute a "mildly restrictive level," at which point it would be easy to find justification to begin cutting rates once inflation approaches its target.
Therefore, based on a baseline forecast where inflation just touches the target next year and then falls slightly below it, he sees "no reason to hike more than twice."
However, if President Lagarde reiterates during her press conference that there is a "broad consensus" on the policy direction, or reminds the public that June's projections were based on an assumption of a total of three rate hikes, market bets on a September hike could receive further confirmation.
Second-Round Effects Absent, Food Risks May Be Brewing
The ECB's primary confidence in being able to wait and see stems from the fact that the long-feared "second-round effects" have yet to materialize.
High energy costs typically transmit to various goods and services, driving up wages and creating a price-wage spiral, but this has not been evident in the data.
Eurozone inflation slowed to 2.8% in June, with price pressures in services and core inflation excluding energy and food also cooling.
Wage growth continues to moderate, the labor market remains generally soft—especially in Germany, the bloc's largest economy—and consumer expectations for future prices have also declined significantly.
Nonetheless, a survey indicates that about one in ten economists have found evidence of inflation expectations beginning to de-anchor, and almost all respondents express at least some concern about second-round effects.
ECB policymakers similarly believe that while these effects may be more delayed and muted, they will still arrive, and the central bank must remain ready to act.
Complicating matters further, this summer's extreme heatwaves across Europe and the El Niño phenomenon may have already damaged crops and pushed up future food prices, while low water levels in key waterways like the Rhine could create shipping bottlenecks.
Barclays warned in a report that, although food inflation has generally eased in recent months, unusually hot weather could again exert upward pressure on food prices.
Middle East Turmoil Shifts Risk Balance: Lagarde's Delicate Balancing Act
Following the June policy meeting, a temporary ceasefire between the US and Iran, coupled with inflation data falling more than expected, once fueled market hopes that the worst was over.
However, with the resumption of hostilities and oil prices again holding firmly above $90 per barrel, tightening expectations have made a comeback.
This forces the ECB not only to answer "how much tightening is enough" but also to clarify its assessment of the balance of risks.
Lagarde will inevitably be asked how the Eurozone's economic performance compares to the baseline and more pessimistic scenarios set in June.
Although oil prices have risen recently, considering the futures curve, their level remains close to a milder path that would see inflation fall faster; conversely, natural gas prices are closer to the adverse scenario.
Benefiting from the brief ceasefire, Lagarde described inflation risks in early July as "more balanced" compared to the time of the June hike; now that fighting has resumed, whether this characterization will be adjusted again will be a key detail for markets to gauge the policy direction.
Simultaneously, the ECB must also confront medium-to-long-term headwinds—persistent trade tensions, high energy costs, and China's continued expansion into key European export markets—suggesting that the Eurozone's industrial sector will face pressure for years to come, thereby suppressing labor demand, which in turn exerts downward pressure on wages and prices.
Beyond Monetary Policy: Lagarde's Personal Future Adds Uncertainty
Beyond the economic and interest rate path, Lagarde's press conference is also likely to face questions about her personal future.
The French President of the ECB continues to fuel speculation that she might step down before her term expires in October next year.
Lagarde recently acknowledged that she had considered leaving early as far back as February this year, when inflation was nearing the 2% target, but the subsequent US attack on Iran prompted her to stay.
More recently, she announced plans to engage in the French electoral campaign in some capacity to raise the visibility of European issues, while stating she would not personally seek public office.
Meanwhile, rumors persist about her potentially taking on a permanent leadership role at the World Economic Forum in Davos.
This personnel uncertainty adds an extra layer of sensitivity to the ECB's future policy communication.
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