ECB Accounts: Another rate hike likely unless inflation outlook improves
- European Central Bank policymakers considered that incoming data provided a strong case for pausing rate hikes in July.
- Some policymakers would not have opposed another increase, highlighting persistent upside risks to inflation from the energy shock.
- Another rate hike is likely to be necessary unless the inflation outlook improves significantly, although no decision has been made for September.
The European Central Bank (ECB) Accounts of the July 22-23 monetary policy meeting show that policymakers remain open to further monetary tightening despite unanimously deciding to keep interest rates unchanged. Members stress that another rate hike will likely be necessary unless the inflation outlook improves significantly, while avoiding any commitment to a move at the September meeting.
The Governing Council considers that incoming economic data provided a strong case for pausing the tightening cycle in July. Headline inflation fell to 2.8% in June from 3.2% in May, while core inflation eased to 2.4% from 2.6%. Underlying price pressures also continued to moderate, with more persistent components of inflation developing more favourably than previously expected.
Wage developments provided additional arguments for keeping rates unchanged. Labour cost pressures are moderating and the softening of labour market conditions reduces the probability that the energy shock will generate significant second-round effects. Policymakers note that these effects have not yet become embedded in domestic prices and wages, while longer-term inflation expectations remain broadly anchored around the ECB's 2% target.
However, the Accounts maintain a hawkish bias. Some members would not have opposed raising rates in July and argued that the likelihood of another increase eventually proving unnecessary was low. They warned that waiting too long could delay inflation's return to target and potentially require more aggressive monetary tightening at a later stage.
Energy prices remain at the heart of the ECB's concerns. Policymakers warn that the full inflationary impact of the recent shock has yet to materialise and that the longer energy prices remain elevated, the greater the risk of broader indirect and second-round effects. High natural gas prices and seasonally low European gas storage levels are among the main upside risks, alongside geopolitical disruptions to energy supply chains.
The Governing Council therefore continues to see risks to inflation as tilted to the upside. Although current evidence on wages, profit margins and inflation expectations remains relatively reassuring, the projected persistence of above-target inflation reinforces the need to monitor the duration and intensity of the energy shock.
Attention now turns to the September meeting, as new economic projections and additional inflation data should provide greater visibility, particularly after consumer prices ticked up in July. The ECB reiterates its data-dependent and meeting-by-meeting approach, making clear that the July pause does not signal the end of the tightening cycle, but equally that a September rate hike is not predetermined.
Markets remain firmly positioned for further tightening, pricing in a 96% chance of a 25-basis-point (bps) interest rate hike in September, according to the ECB Watch tool.
Market reaction
The Euro (EUR) shows little reaction to the release, with EUR/USD remaining under modest bearish pressure around 1.1640 on Thursday at the time of writing, down 0.08% on the day. Traders remain cautious ahead of Federal Reserve (Fed) Chair Kevin Warsh's speech at the Jackson Hole Symposium on Friday.
ECB FAQs
The European Central Bank (ECB) in Frankfurt, Germany, is the reserve bank for the Eurozone. The ECB sets interest rates and manages monetary policy for the region. The ECB primary mandate is to maintain price stability, which means keeping inflation at around 2%. Its primary tool for achieving this is by raising or lowering interest rates. Relatively high interest rates will usually result in a stronger Euro and vice versa. The ECB Governing Council makes monetary policy decisions at meetings held eight times a year. Decisions are made by heads of the Eurozone national banks and six permanent members, including the President of the ECB, Christine Lagarde.
In extreme situations, the European Central Bank can enact a policy tool called Quantitative Easing. QE is the process by which the ECB prints Euros and uses them to buy assets – usually government or corporate bonds – from banks and other financial institutions. QE usually results in a weaker Euro. QE is a last resort when simply lowering interest rates is unlikely to achieve the objective of price stability. The ECB used it during the Great Financial Crisis in 2009-11, in 2015 when inflation remained stubbornly low, as well as during the covid pandemic.
Quantitative tightening (QT) is the reverse of QE. It is undertaken after QE when an economic recovery is underway and inflation starts rising. Whilst in QE the European Central Bank (ECB) purchases government and corporate bonds from financial institutions to provide them with liquidity, in QT the ECB stops buying more bonds, and stops reinvesting the principal maturing on the bonds it already holds. It is usually positive (or bullish) for the Euro.
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