An ECB hold masks a persistent inflation dilemma
As expected, the ECB left interest rates unchanged, but the headline tells only part of the story.
Markets had already priced a July hold and were looking for guidance on the September decision. With that in mind, the press conference delivered a notably hawkish message.
Lagarde confirmed that inflation risks to the upside remain and, crucially, said the ECB had removed its earlier Sintra assessment that those risks had become “more balanced”.
Alongside acknowledgement that some governors questioned whether an increase today would have been warranted, this was as strong a signal as Lagarde is likely to give that another hike remains firmly on the table.
Admittedly, recent inflation data has given policymakers enough room to wait for now. Headline inflation eased from 3.2% to 2.8% in June, while core inflation fell from 2.6% to 2.4%, suggesting that broad second-round effects have not yet become entrenched. Lagarde was clear that the ECB is focused on those effects but does not yet see sufficient evidence to justify immediate action. Even so, persistence is a growing risk.
The ECB expects inflation to remain above target into the first half of 2027, and the geopolitical backdrop also appears to be deteriorating faster than previously assumed.
Lagarde commented that the Bank’s mild scenario now looks “quite unlikely”, noting that abrupt changes in the conflict and energy prices have made the outlook increasingly difficult. Indeed, with Brent reaching $100 during the press conference, the ECB’s June conditioning assumptions already look stale.
So, while the ECB is waiting for evidence that higher energy and input costs are spreading more broadly through the economy, if that confirmation arrives, the threshold for further tightening now looks much lower than it did back in June.
The ECB has not promised a September move, but it has come close to giving markets a green light to price one given today’s guidance.
The prospect of tighter policy should help slow the euro’s fall. But absent a meaningful cooling in Middle East hostilities, growth concerns are likely to become an increasingly pronounced drag in the coming weeks and months.