The European Central Bank is set to announce its interest rate decision at 20:15 Beijing time on Thursday. Against a backdrop where conflict in Iran has driven up energy prices, reigniting inflationary pressures within the eurozone, markets anticipate the ECB will implement a rate hike. This move is seen as an attempt to curb inflation before the cost shock spreads more broadly through the economy.
Current inflation in the eurozone exceeds 3%, significantly above the ECB's 2% target, while economic growth remains weak. This combination of "high inflation and low growth" has led to a divergence of views within academia over whether policy should be tightened, although markets have largely priced in expectations for this hike already.
Markets expect a 25 basis point increase, which would raise the ECB's benchmark deposit rate from 2.0% to 2.25%, marking the first hike in nearly three years. However, policymakers are unlikely to provide clear guidance on future actions this week. Despite this, financial markets are still betting on the possibility of two further rate hikes next year, with the next one potentially occurring as early as September.
At 20:45, ECB President Christine Lagarde will hold a monetary policy press conference.
Managing Expectations and Policy Rationale
In internal discussions, ECB officials are inclined to view this move as a "pre-emptive hike" – acting in advance to stabilize market judgments about future inflation rather than responding to runaway price increases.
Professor Richard Portes of London Business School noted, "They have to hike this time, if only to manage expectations. If they don't, the market view will be that the ECB is willing to let inflation rip." This perspective reflects policymakers' concern over credibility, having faced criticism for a slow response during the post-pandemic inflation surge in 2022.
To bolster the rationale for the hike, the ECB may simultaneously raise its quarterly inflation forecasts on Thursday, bringing them closer to the "adverse scenario" published in March. That scenario projected inflation peaking at 4.2% in the final quarter of this year before declining significantly by 2027.
Although consumers, businesses, and financial market participants have raised their short-term price expectations, medium-term inflation expectations remain close to target and are notably lower than levels seen at the start of the Russia-Ukraine conflict. Stefan Gerlach, Chief Economist at EFG Bank in Switzerland and former Deputy Governor of the Central Bank of Ireland, wrote in a blog, "The argument for hiking in June is not that expectations have become unanchored, but that acting now is precisely to prevent them from becoming unanchored."
Controversy Amid Economic Weakness
Nevertheless, there is some opposition to a rate hike, primarily focused on economic fundamentals. Some economists argue that tightening policy when demand is already weak could have negative consequences.
Holger Schmieding of Berenberg Bank warned that the ECB is "heading for a policy mistake" against a backdrop of a stagnant labor market and weak consumer demand. He stated in a report, "Inevitable short-lived price spikes... against a backdrop of eroding demand, seem unlikely to morph into a longer-term inflation problem that would require rate hikes to solve."
An analysis of eurozone corporate earnings calls by Reuters shows that, excluding the financial sector, only about 40% of companies have raised or plan to raise prices—half the proportion seen during the 2022 energy price surge. Eric Dor, Director of Economic Research at IESEG School of Management in France, believes the ECB overestimates its influence on household and business expectations when inflation is primarily driven by fuel costs rather than domestic demand.
Despite the divergence in views, recent statements from within the ECB have taken a more hawkish turn. Chief Economist Philip Lane, often seen as leaning dovish, pointed out that compared to the Ukraine crisis, the shock related to Iran has a broader impact as it affects global energy markets, not just Europe.
This assessment has also contributed to a widespread expectation among investors that borrowing costs will continue to rise. Henry Cook, Senior Economist at Mitsubishi UFJ Financial Group (MUFG) in London, said, "We expect the ECB to leave the door open to further action but want to preserve plenty of flexibility amid heightened uncertainty."
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