The European Central Bank is widely expected to leave interest rates unchanged on Thursday, while keeping open the possibility of another increase in September as renewed energy price rises threaten to push inflation higher.
The ECB raised rates in June and signalled that further tightening could follow. Since then, however, data on inflation, wages, economic activity and consumer price expectations have been relatively moderate, reducing the need for an immediate follow-up increase.
Oil prices have since risen above $90 a barrel as conflict continues in the Middle East, raising concerns that higher energy costs could eventually spread across the wider economy.
“We think the ECB will enter a hawkish pause,” said Oliver Rakau of Oxford Economics.
He said current economic data narrowly supported the possibility of further rate increases, broadly matching the ECB’s June forecasts and market expectations.
Financial markets are now pricing in between two and three additional rate hikes, with the first expected by October and a second potentially arriving by next April. Economists, however, say those expectations may be driven more by oil prices than by underlying economic conditions.
Jens Eisenschmidt of Morgan Stanley said inflation could remain close to the ECB’s target next year even with oil prices at current levels. He argued that the central bank may not need to raise rates more than twice, with a deposit rate of 2.5 per cent potentially providing enough restraint to control price growth.
ECB President Christine Lagarde is therefore expected to strike a careful balance during the central bank’s latest meeting. She will need to signal that policymakers remain alert to renewed price pressures without encouraging financial markets to expect more rate increases than the economic outlook supports.
A key factor allowing the ECB to wait is the absence of clear second-round effects from higher energy prices.
Energy costs can raise prices across the economy and eventually prompt workers to demand higher wages, creating a cycle of rising wages and prices. So far, wage growth has continued to slow, while labour market conditions have weakened, particularly in Germany.
Businesses surveyed by the ECB also expect wage pressures to remain subdued. Consumers have lowered their inflation expectations, while recent data has shown little evidence of broader price effects from the energy shock. Services inflation slowed last month.
The euro zone economy also faces continued pressure from trade tensions, high energy costs and growing Chinese competition in important export markets. Those forces could weaken demand for workers and limit wage growth.
The ECB remains cautious, however, warning that delayed second-round effects could still emerge.
Extreme summer weather across Europe adds another risk. Crop damage and low water levels on major rivers could raise food prices and disrupt transport, while unusually high temperatures may add to inflationary pressure in the months ahead.
