ECB set to hike rates Thursday as Middle East conflict pushes inflation to 3-year high

The European Central Bank is widely expected to raise its deposit rate by 25 basis points to 2.5% when policymakers meet Thursday, as the ongoing U.S.-Iran conflict drives up energy costs and pushes eurozone inflation to a three-year high.

Traders have fully priced in the quarter-point increase, which would mark the ECB's second rate hike this year after it resumed tightening in June following a pause in July. Eurozone inflation climbed to 3.3% in August, well above the ECB's 2% target, driven almost entirely by surging oil and natural gas prices.reuters+1

"We expect the ECB to hike rates by 25 basis points. Another insurance rate hike," said ING's global head of macro Carsten Brzeski, according to Reuters. "Or for those who don't like this term: a dovish rate hike."reuters

Energy Shock Drives the Decision

Brent crude has risen over the past month as tit-for-tat strikes between the U.S. and Iran on vessels in the Strait of Hormuz have heightened fears of prolonged supply disruption. European natural gas prices have hit their highest levels since early 2023.kelo+1

ECB governing council members Isabel Schnabel and Joachim Nagel have both signaled in recent days that policymakers will resume hiking rates. Nagel, also the head of the German central bank, told France's Le Monde that "oil and gas prices keep going up and down" and that the situation was "uncomfortable — also from a monetary policy perspective."newswav

Pause Expected After September

Most economists polled by Reuters expect the ECB to hold steady after this week's move, arguing that further tightening risks weighing on growth. There is little evidence that energy-driven inflation is broadening into the wider economy — services inflation dropped in August, and wage growth continues to slow.economictimes+1

Not all observers agree the hike is warranted. "We consider another hike a mistake because there is almost no evidence of knock-on effects," Felix Schmidt, senior economist at Berenberg bank, told AFP. "You can't tackle a supply shock with tighter monetary policy."newswav

Still, traders are pricing in a meaningful chance of another increase by December, reflecting persistent uncertainty over energy costs.reuters

Bond Yields and U.S. Moves Add Complexity

Rising government bond yields across Europe are tightening financial conditions independently of ECB action. Ten-year borrowing costs in France and Italy have risen roughly 65 basis points this year, while German yields have climbed about 50 basis points.economictimes+1

European officials are also uneasy after the U.S. sold euros to buy yen in a recent currency intervention without providing customary advance notice, sources told Reuters — a move that has added to concerns about increased volatility in financial markets.reuters

ECB President Christine Lagarde is expected to offer little forward guidance at her post-decision press conference, maintaining the bank's meeting-by-meeting approach as policymakers navigate what Nagel called the "many uncertainties" ahead.newswav