Lagarde backs hawkish ECB stance after rate hike to 2.5%

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Lagarde backs rate hike

Highlights

Lagarde backed a unanimous ECB decision to raise the deposit rate to 2.5%.
The ECB now expects inflation to average 3% in 2026 and 2.5% in 2027.
Markets are pricing three additional rate increases by October 2027.

The quarter-point increase was the ECB's second since the Iran war began and followed its initial move in June, Bloomberg reported. Lagarde described the decision as a clear-cut choice that remained appropriate under each of the three economic scenarios considered by policymakers, while maintaining that the central bank would not commit in advance to a specific rate path.

Lagarde keeps focus on persistent inflation

The ECB's latest projections reinforced the case for tighter policy. Inflation is expected to average 3% in 2026, before slowing to 2.5% in 2027 and 2.1% in 2028. Consumer prices rose 3.3% from a year earlier in August, driven partly by the renewed surge in energy costs.

Oil reaching about $105 a barrel and European natural gas prices returning to levels last seen during the winter following Russia's invasion of Ukraine have complicated the inflation outlook. Lagarde indicated that higher energy costs are likely to filter gradually into food prices and underlying inflation, keeping headline inflation above the ECB's 2% target into the first half of 2027.

There are also signs of easing pressure. Measures of underlying inflation and services inflation have declined, while wage growth has moderated.

Stronger economy gives ECB room to move

Economic resilience is another reason investors expect additional increases. Eurozone output expanded 0.6% in the second quarter, while the ECB raised its full-year growth forecast to 0.9%.

Lagarde said the second-quarter expansion was broad across countries and industries, with evidence that momentum continued into the third quarter. Manufacturing is expanding at its fastest pace in more than four years, supported by digital investment and government spending on infrastructure and defense.

Markets prepare for a longer tightening cycle

Lagarde stopped short of endorsing market expectations for further increases, preserving the ECB's meeting-by-meeting approach. Investors nevertheless now fully price in three additional hikes by October 2027, putting the ECB on a notably more restrictive trajectory than other major central banks.

The combination of 3.3% inflation, a 2.5% deposit rate, and unexpectedly resilient economic activity changes the debate from whether the ECB should respond to the energy shock to how far it may need to go. If energy prices remain elevated and inflation proves persistent, Thursday's increase may become another stage in a longer tightening cycle rather than its endpoint.

Earlier, we reported that Christine Lagarde may leave ECB earlier than expected.

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