If inflation conditions fail to improve, the European Central Bank will resume raising interest rates in December — a signal that is fueling growing market expectations for another tightening of monetary policy within the year.
According to people familiar with the matter cited by Bloomberg, ECB officials broadly believe that, based on current data and the economic impact of the Middle East war, an additional 25 basis point rate hike may be needed to curb inflation. The people requested anonymity because the discussions are internal matters.
The market has already priced this in, with current trading showing roughly an 85% probability of another 25 basis point hike in December, and investors expecting the tightening cycle to extend into 2027, when at least one more move may occur.
No move this week, but the direction toward higher rates is "clear"
The ECB kept its deposit rate unchanged at 2.5% this week, its third rate decision since the Iran war shocked energy markets and pushed inflation to nearly twice its 2% target.
President Lagarde announced she would step down early, a development that somewhat overshadowed the focus of the decision itself, but she still made clear that the direction of interest rates is "clearly discernible."
Lagarde revealed that a rate hike was indeed discussed at this week's meeting before officials chose to hold steady. People familiar with the matter said this week's internal discussions were "extremely intense." The 2.5% deposit rate sits at the upper end of the range in which monetary policy is considered neutral for the economy.
Inflation risks tilted to the upside, while economic growth pressures emerge
On the inflation assessment, although Lagarde played down the risk of price pressures spilling beyond the energy sector, she also stressed that upside risks remain the main bias; by contrast, the risks to economic growth face the opposite direction — concerns that growth will fall short of expectations are mounting.
Data due Friday are expected to show third-quarter economic growth slowing to 0.2% from 0.6% in the second quarter, although the second-quarter figure was clearly inflated by Ireland's strong performance. Meanwhile, consumer price growth is expected to accelerate to 3.9% from 3.8%.
Analysts: The tightening cycle may be nearing its end
Bloomberg economists David Powell and Simona Delle Chiaie believe that "the Governing Council is laying the groundwork to end this tightening cycle, even as the ECB keeps the door open to another rate hike in December."
The two analysts said Lagarde's recent remarks further reinforced their judgment — her comments placed more emphasis on limited signs of spillover effects from the energy shock and on the effects of tighter financial conditions.
People familiar with the matter also cautioned that no decision has been made yet and the situation could change rapidly, especially given the unpredictable developments in the Middle East.
Comments