ECB September rate hike seen as ‘done deal’ despite Iran war fallout

Swap markets are pricing roughly a 90% chance that the European Central Bank will raise interest rates by 25 basis points at its September meeting, as stronger-than-expected eurozone growth and persistent inflation override concerns about the economic fallout from the war in Iran.fxstreet

The eurozone economy expanded 0.4% in the second quarter, driven by a surge in AI-related investment and increased government spending that more than offset the drag from elevated energy costs tied to the Middle East conflict. Core inflation also surprised to the upside, suggesting that second-round effects from the energy price spike have not fully dissipated.globalbankingandfinance+1

Consumer Confidence Under Strain

Even as headline growth holds up, the ECB warned Monday that consumer confidence "has deteriorated markedly" in the wake of the Iran conflict and the resulting rise in fuel prices. Higher-income households have postponed discretionary purchases such as luxury clothing and travel, while lower-income households have begun cutting back on dining out and everyday indulgences.eunews

The central bank's economists cautioned that "additional downside risks could materialise if households were to perceive the real income losses stemming from the conflict as persistent," warning that a sentiment-driven slowdown in consumption could become entrenched.eunews

Factory Output Masks Fragility

Eurozone manufacturing data released Monday offered a mixed picture. The S&P Global ↗ 1.05% Eurozone Manufacturing PMI rose to 51.9 in July, its highest reading since April, with output hitting levels not seen since March 2022. But new orders rose only marginally, and factories were largely running on backlogs rather than fresh demand, according to Reuters.globalbankingandfinance

"Euro zone factories are enjoying something of a summer growth spurt … However, there are signs that this good news may prove short-lived," said Chris Williamson, chief business economist at S&P Global Market Intelligence. Factory employment continued to fall, and export orders declined across France, Spain, Italy, and Austria.globalbankingandfinance

Rate Hike Calculus

Analysts at FXStreet described the September hike as "effectively a done deal even in the event of a peace deal," noting that the eurozone's exposure to imported energy inflation makes further tightening necessary regardless of geopolitical developments. Three ECB policymakers said last month that rates may need to rise again, though they stopped short of explicitly calling for a September move. Eurozone inflation stood at 2.9% in July, up from 2.8% the prior month.fxstreet+1

The ECB acknowledged one encouraging sign: household confidence has improved slightly from its post-war nadir. But it added that "the close relationship between consumer confidence and consumption growth suggests that there could be renewed challenges to consumption if the recent recovery in confidence were to prove temporary".eunews