By Francesco Canepa and Balazs Koranyi

FRANKFURT, June 11 (Reuters) – The European Central Bank is all but certain to raise interest rates on Thursday in the hope of nipping higher inflation in the bud before a surge in energy costs triggered by the Iran war spreads ‌more broadly across the euro zone economy.

The well-telegraphed move would come as inflation in the 21-country currency bloc is already above 3%, well in ‌excess of the ECB’s 2% target, and economic growth is very weak – a backdrop that has economists split over the case for tighter policy.

ECB policymakers, some of whom had already pushed for action ​in April, are nonetheless expected to press ahead, seeking to keep a lid on inflation expectations and to safeguard their credibility after being slow to react to a post-pandemic inflation spike in 2022.

“They have to raise rates this time, simply to manage expectations,” Richard Portes, a professor at the London Business School, said. “If they don’t, then the market’s view will be that the ECB is willing to let inflation rip.”

Thursday’s hike would be the first in nearly three years and take the ECB’s benchmark deposit ‌rate to 2.25% from 2.0%. Sources have told Reuters the ⁠ECB is unlikely to commit to further rate rises this week but financial markets expect another two over the next year, with a next move possible as soon as September.

AN ‘INSURANCE HIKE’ THAT UNDERPINS EXPECTATIONS

Several ECB watchers have characterised the expected move as ⁠an “insurance hike” – a precautionary step that could be reversed if price pressures fade.

Supporting the case for action, the ECB is likely to raise its quarterly inflation projections on Thursday, bringing them closer to its “adverse” scenario published in March, which saw inflation peaking at 4.2% in the final quarter of this year before falling back sharply in 2027.

Consumers, companies and ​financial ​investors have revised their own views about price hikes, although medium-term expectations remain close to ​the ECB target and far from their levels in the aftermath ‌of Russia’s invasion of Ukraine.

“The case for raising rates in June is not that expectations have already become unmoored, but that acting now is precisely what keeps them from doing so,” Stefan Gerlach, Chief Economist at EFG Bank in Zurich and former deputy governor of the Central Bank of Ireland, wrote in a blog post.

HEADING FOR A POLICY MISTAKE?

Not all economists are convinced. Some warn the ECB risks tightening into an economy that is already paying a high price for the Iran war.

Berenberg’s Holger Schmieding said the ECB was “heading for a policy mistake” given a stagnant labour market and weak consumer demand.

“Amid the ongoing destruction of demand, the inevitable ‌temporary surge in prices … seems unlikely to turn into a protracted inflation problem that would ​need to be addressed by higher rates,” he wrote in a note.

A Reuters analysis of earnings ​call transcripts by euro zone companies showed just 40% of those outside ​the financial sector had raised prices or were planning to do so, roughly half the share seen as the Ukraine war ‌pushed up energy prices in 2022.

Eric Dor, director of economic ​studies at France’s IESEG School of Management, said ​the ECB was overestimating its ability to influence household and business expectations, particularly in a situation where inflation is driven by fuel costs rather than domestic demand.

But the ECB has sharpened its messaging in support of tighter policy. Chief Economist Philip Lane – typically seen as an inflation “dove” – has said ​the Iran-related shock may be broader in scope than ‌the Ukraine crisis, as it affects global energy markets rather than primarily Europe.

That has left most investors expecting borrowing costs to be hiked ​further.

“We expect the ECB will leave the door open to more action but want to retain plenty of flexibility amid elevated uncertainty,” ​said Henry Cook, a senior economist at broker MUFG in London.

(Editing by Catherine Evans)