ECB Plans Another Rate Hike while Maintaining Flexibility for September

The European Central Bank (ECB) is set to raise interest rates for the ninth consecutive time on Thursday, amid the ongoing battle against surging inflation and mounting evidence of an economic slowdown. With inflation still remaining stubbornly high and projected to take until 2025 to return to the 2% target, the ECB has increased borrowing costs by 4 percentage points since July of the previous year.

While another quarter-point rate hike is widely expected this month, the ECB is likely to abandon its practice of providing forward guidance on its next moves, opting for a “data-dependent” approach instead. This shift may leave investors uncertain about whether further rate increases will occur in September or if the central bank’s tightening spree will come to an end after the July hike.

Although the end of rate increases appears to be nearing, there remains a debate among policymakers about whether one more small hike will be necessary before halting the tightening cycle for an extended period.

The core issue faced by the ECB is that inflation is receding at a slower pace than desired. The initial price surge driven by energy costs has spilled over into other sectors through higher mark-ups, contributing to the rising cost of services. While overall inflation has declined from its peak in October, underlying price growth remains stubbornly high and may have even accelerated in the current month.

Moreover, the tight labor market, characterized by record-low unemployment, raises concerns that wage increases could accelerate in the coming years. Trade unions are expected to leverage their increased bargaining power to counteract real income losses due to inflation.

Given these economic conditions, many investors and analysts anticipate the ECB will implement another rate hike in September, keeping a close eye on wage data during the autumn to determine whether further tightening is warranted.

ECB board member Isabel Schnabel and other policymakers have emphasized that raising rates too far would be less costly than not taking sufficient action to address inflationary pressures. Furthermore, the recent rate hike by the U.S. Federal Reserve, along with their indications of potential future tightening, add to the ECB’s inclination for more rate increases.

Considering these factors, analysts predict a final 25 basis point rate hike in September, with the focus later shifting to the ECB’s balance sheet towards the end of the year.