ECB remains cautious on war and inflation risks

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Lagarde sees no rate-hike need

Highlights

Lagarde said the ECB sees no need for a stronger policy response yet.
Euro-area inflation remains above 3%, while core inflation rose to 2.6% in May.
Markets still expect at least one more ECB rate hike this year.

Inflation risks remain contained

Speaking to European lawmakers in Brussels on Monday, Lagarde said the ECB had not seen evidence that households expect elevated inflation to last or that second-round effects are taking hold, Bloomberg reports. That matters because the central bank is watching whether higher energy costs pass through into wages, company pricing decisions, and longer-term inflation expectations.

Euro-area inflation remains above the ECB’s 2% target, with headline price growth still above 3%. Core inflation, which strips out food and energy, accelerated to 2.6% in May from 2.2% in April, showing that underlying pressure has not fully disappeared.

Still, Lagarde said inflation is expected to move back toward 2% with appropriate monetary policy. The ECB has repeatedly said it will monitor the size and persistence of energy shocks, along with their impact on wage-setting and inflation expectations.

Markets trim rate-hike bets

Investors are trying to judge whether the ECB will follow its first rate hike since 2023 with another increase. Markets still expect at least one more quarter-point move this year, which would lift the deposit rate to 2.5%.

After Lagarde’s comments, traders reduced expectations for tightening. Markets priced about 33 basis points of increases by year-end, down from 37 basis points earlier. German government bonds rallied, sending the two-year yield six basis points lower to 2.59%.

The change reflected relief that the ECB is not yet preparing a more aggressive response to the war’s economic impact. Lagarde welcomed recent progress toward a U.S.-Iran peace deal but warned that the situation remains fragile. Oil prices also eased below $80 a barrel as Washington and Tehran worked on a roadmap toward a final agreement, reducing some pressure on policymakers.

A meeting-by-meeting ECB

Lagarde’s message keeps the ECB in a flexible position. The central bank does not want to ignore a large energy shock, but it also does not want to overreact if inflation expectations stay anchored and the Middle East disruption proves temporary.

That leaves officials focused on data rather than a fixed rate path. For markets, the key question is whether higher energy prices feed into broader inflation. If they do, the ECB may need to tighten further. If not, Lagarde’s comments suggest a measured approach remains more likely than a forceful one.

As previously covered, inflation pressure pushes the ECB toward a rate hike.

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