ECB signals further rate hikes as energy risks threaten inflation outlook

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ECB signals further rate hikes

Highlights

The ECB raised its deposit rate to 2.5%.
Officials remain open to further rate increases.
Gas, electricity, and diesel are key inflation risks.
Markets price three more hikes by October 2027.

Bloomberg reported that Governing Council member Peter Kazimir sees inflation risks as clearly tilted to the upside and says the ECB is prepared to tighten policy again if incoming evidence requires it. Executive Board member Isabel Schnabel separately highlighted recent energy-price developments as a growing concern for the central bank.

Energy shock keeps pressure on the ECB

The ECB raised its deposit rate by 25 basis points to 2.5% last week, its second increase since the Iran war began. Higher oil and other energy costs have complicated the inflation outlook even as the euro-zone economy has proved more resilient than previously expected.

Natural gas is becoming a particular concern. European gas prices have nearly tripled this year, while storage levels remain unusually low ahead of winter. Further supply disruptions or colder-than-normal weather could intensify competition with Asian buyers for LNG and push costs higher.

Diesel is another source of pressure because reduced refining capacity cannot be restored quickly. The combination increases the risk that the energy shock lasts long enough to spread beyond headline inflation.

Policymakers watch for second-round effects

The ECB is now trying to determine whether persistent energy costs are changing inflation expectations and feeding into wages, goods, and services. Kazimir indicated that policymakers need more evidence on demand and labor-market conditions before judging the scale of those second-round effects.

Other Governing Council members are also signaling that tightening may not be finished. Lithuania's Gediminas Simkus sees October as an opportunity to reassess the inflation outlook, while December could provide a broader review of economic conditions. Latvia's Martins Kazaks has indicated that rates may ultimately need to move into restrictive territory.

Schnabel similarly stressed the importance of incoming data, including core inflation and prices for non-energy goods and services.

Markets prepare for a longer tightening cycle

The ECB has avoided committing to a predetermined rate path, but the balance of risks has shifted since energy prices surged. Traders are now pricing three additional rate increases by October 2027, reflecting expectations that policymakers may have to keep borrowing costs higher for longer.

The key issue is whether the energy shock remains concentrated in fuel and utility bills or becomes embedded in wages and underlying inflation. With the deposit rate already at 2.5% and European gas inventories unusually low before winter, evidence of broader price pressure could strengthen the case for another quarter-point increase as early as the coming meetings.

Earlier, we reported that Goldman Sachs and JPMorgan strengthen September Fed hike call.

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