European Central Bank policymakers are prepared to raise interest rates at their September meeting to contain the economic fallout from the Iran war, but they have little appetite for signaling additional tightening beyond that, according to three sources familiar with the discussions who spoke on condition of anonymity.
The central bank lifted borrowing costs in June for the first time in nearly three years, a move aimed at preventing war-driven energy price increases from spreading too broadly across the economy. With inflation still hovering near 3%, the Iran conflict ongoing, and the euro zone economy showing resilience, governors now believe the time has come to raise the policy rate again, to 2.50% from the current 2.25%, the sources said.
A spokesperson for the ECB declined to comment.
The expected increase was already embedded in the assumptions underlying the central bank’s economic projections published in June. Policymakers view the move as a signal of the ECB’s determination to avoid a repeat of the punishing inflation surge that followed Russia’s invasion of Ukraine in 2022, the sources added.
Rising natural gas prices, a critical fuel for the energy-importing euro zone, along with elevated petrol costs at the pump, were identified as the primary drivers of current inflationary pressure. Policymakers also pointed to output data and business surveys indicating that the euro zone economy has performed better than anticipated, suggesting that the ECB’s efforts to rein in price growth have not placed undue strain on economic activity.
Long-term inflation expectations remain well anchored at the ECB’s 2% target, which has led policymakers to conclude there is no need to hint at further tightening when they meet in September. Financial markets are currently pricing in one or two additional hikes beyond the upcoming meeting.
The sources noted that a clearer picture will emerge when August inflation data is published next week, followed by the ECB staff’s updated economic projections to be presented at the September 9-10 policy meeting.
Key Data PointsDetailsCurrent policy rate2.25%Expected rate after September meeting2.50%Inflation levelNear 3%ECB inflation target2%September meeting datesSept 9-10
Note: Figures reflect the policy rate level and inflation conditions as described by sources familiar with ECB discussions.
The June rate hike, which ended a nearly three-year stretch of unchanged policy, was designed to prevent energy price shocks from becoming embedded in broader price dynamics. The current situation echoes the challenge the ECB faced in 2022, when Russia’s full-scale invasion of Ukraine triggered a spike in energy costs that ultimately pushed euro zone inflation into double digits and forced an aggressive tightening cycle.
By moving again in September, the central bank would reinforce its commitment to price stability while stopping short of committing to a longer campaign of rate increases. That measured approach reflects a delicate balancing act: inflation remains above target, but the economy has shown enough underlying strength to absorb higher borrowing costs without tipping into recession.
For investors and market participants, the September decision is now widely anticipated. The more consequential question is what comes after. The sources’ indication that ECB governors see no need to signal further hikes suggests the bank may be approaching the end of its current tightening phase, barring a significant deterioration in the inflation outlook or an escalation of the Iran conflict that reignites energy price pressures.