ECB set to hike to 2.5% as insurance, then likely pause

The European Central Bank looks set to deliver a quarter-point increase to 2.5% on Thursday, an insurance move against resurgent energy inflation that traders expect to cap the tightening cycle.

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

Euro zone inflation climbed back above 3 percent in August on higher energy costs, with Brent crude rising over the past month and European gas prices at their highest since early 2023. Yet services inflation dropped despite the jump, the labour market is soft and wage growth is slowing — evidence the price shock has yet to broaden into core pressures.

Policymakers have little appetite to signal further increases, and most economists polled by Reuters expect the ECB to stop after September, wary that more tightening would hurt growth. Traders still price a high chance of another move by December and one more next year, leaving the path hostage to oil.

The decision follows a quarter-point hike in July that lifted the deposit rate to 2.25%, with minutes of that meeting flagging readiness to move again. The open question is how far the energy shock transmits. "The hot topics for investors will be comments about indirect effects and second round effects, how intensely and with what time delay energy prices will eventually translate into core inflation," said Marco Wagner, economist at Commerzbank. "There is a lot of uncertainty around that."

New projections due alongside the decision are expected to keep inflation and growth forecasts broadly unchanged, though some anticipate GDP estimates nudged higher. Euro zone business activity continued to post solid growth in August, matching July's pace — the fastest this year — according to S&P Global data. "They will probably revise up their 2026 growth forecast slightly," said Pia Fromlet, macro economist at SEB.

The last time the ECB tightened into an energy-driven inflation scare, in 2022, it delivered a run of consecutive hikes before the shock faded and the cycle reversed within roughly 18 months. A similar dynamic now would argue for restraint, but the U.S.-Iran conflict keeps the risk skewed toward more tightening if crude keeps climbing.

Bond selloff does some of the ECB's work

A separate thread is the global bond selloff, which has tightened financial conditions and done part of the ECB's job. Ten-year borrowing costs in France, facing a particularly perilous annual budget battle, and Italy are up around 65 basis points each this year, while Germany's have climbed 50 basis points. "The ECB is always careful in how it talks about long-dated bonds and is likely to stress that only if the moves are out of line with the fundamentals are they likely to act," said Michael Metcalfe, head of macro strategy at State Street. "That doesn't seem to be the case."

European central bankers are also watching Washington's more interventionist turn, after the U.S. sold euros to buy yen and bought Treasury bonds without the customary heads-up, sources told Reuters. Barclays' head of euro rates strategy Rohan Khanna noted the last coordinated yen intervention followed the 2011 Fukushima disaster, when the ECB took part. The grievance, he said, is more about being blindsided than the policy itself.

For markets, the stakes are whether Thursday's hike is the last. If oil prices hold near current levels and inflation stays contained to energy, the ECB can pause and let the bond market do the tightening. If the U.S.-Iran conflict escalates further, traders' December expectations for another move will harden into a near-certainty.

This article is for informational purposes only and does not constitute investment advice.