The European Central Bank (ECB) kept interest rates unchanged as expected on Thursday, but opened the door to another increase in September, as renewed conflict in the Middle East has largely erased any hope of a quick moderation in energy costs.
The ECB raised rates in June and hinted at more to come, but a string of benign data since then – on prices, wages, economic activity and inflation expectations – had made a quick follow-up step less urgent.
The return of oil prices to $100 per barrel as the U.S.-Israeli war on Iran disrupts shipping did stir talk of policy tightening at this month's policy meeting, ECB President Christine Lagarde said, supporting market bets that a rate hike in September is likely.
"There were some governors who asked themselves whether we should not consider a hike; in other words, raising the three interest rates," Lagarde told a news conference. The Governing Council's decision to keep the benchmark deposit rate unchanged at 2.25% was nevertheless unanimous, she said.
The ECB had flagged a hold in the weeks leading up to Thursday's meeting on the premise that energy prices were falling quickly and moving closer to the mildest of three scenarios it set out in March.
But the recent reversal, coupled with a surge in natural gas prices to more than three-year highs, has also reset energy price expectations.
"As we stand now today, (the milder scenario) looks quite unlikely, let's face it," Lagarde said. "The full effects of the energy shock have yet to play out."
Economists said that was consistent with a hike in September.
"Lagarde's comments at the press conference clearly point to a September rate hike," ING economist Carsten Brzeski said. "The European Central Bank has again turned more hawkish, suggesting that a September rate hike is almost a done deal."
The U.S. Federal Reserve (Fed) and the Bank of England (BoE), both of which make rate decisions next week, are also weighing the timing of possible hikes in months to come.
For the ECB, investors are betting on almost three more interest rate increases in the coming year, with a first move fully priced in by October and the second by next February. This pricing reflects energy prices more than economic fundamentals, however, and most economists polled by Reuters say the 21-country eurozone will need far less policy tightening to keep a lid on inflation, which could hover around 3% in the coming months. The ECB targets an inflation rate of 2%.
The key reason the ECB was in no rush to act on Thursday was that long-feared second-round effects of the energy price spike have yet to materialize.
"We are not seeing a second-round effect," Lagarde said.
Firms surveyed by the bank did not point to such impacts in their pricing or pay decisions and wage growth is continuing to slow, as the ECB has long forecast, Lagarde said: "None of those elements for the moment... are giving us second-round effects indications."
One reason why such impacts may be slow to materialize is that the labor market remains relatively soft – particularly in Germany, the bloc's biggest economy – while surveys point to muted pay pressures. Consumers have dialled back their price expectations and services inflation actually slowed last month.
Trade tensions, high energy costs and China's expansion into some of Europe's key export markets, meanwhile, suggest that the bloc's industries will continue to struggle, putting downward pressure on labor demand.
Scorching summer weather in much of Europe this month is a potential risk, however, as Lagarde acknowledged. The heat may have damaged crops and could push up food prices, while low water levels on key rivers could create shipping bottlenecks.
Asked about persistent rumors that she may leave the ECB early, Lagarde said she was not about to depart but also did not say she would stay until her term expires in late 2027.
"You are not going to see the back of me before 2027," the ECB president said. "When there are clouds on the horizon, the captain stays on the ship."
