ECB Accounts: Another rate hike likely unless inflation outlook improves

The European Central Bank (ECB) Accounts of the July 22-23 monetary policy meeting show that policymakers remain open to further monetary tightening despite unanimously deciding to keep interest rates unchanged. Members stress that another rate hike will likely be necessary unless the inflation outlook improves significantly, while avoiding any commitment to a move at the September meeting.

The Governing Council considers that incoming economic data provided a strong case for pausing the tightening cycle in July. Headline inflation fell to 2.8% in June from 3.2% in May, while core inflation eased to 2.4% from 2.6%. Underlying price pressures also continued to moderate, with more persistent components of inflation developing more favourably than previously expected.

Wage developments provided additional arguments for keeping rates unchanged. Labour cost pressures are moderating and the softening of labour market conditions reduces the probability that the energy shock will generate significant second-round effects. Policymakers note that these effects have not yet become embedded in domestic prices and wages, while longer-term inflation expectations remain broadly anchored around the ECB's 2% target.

However, the Accounts maintain a hawkish bias. Some members would not have opposed raising rates in July and argued that the likelihood of another increase eventually proving unnecessary was low. They warned that waiting too long could delay inflation's return to target and potentially require more aggressive monetary tightening at a later stage.

Energy prices remain at the heart of the ECB's concerns. Policymakers warn that the full inflationary impact of the recent shock has yet to materialise and that the longer energy prices remain elevated, the greater the risk of broader indirect and second-round effects. High natural gas prices and seasonally low European gas storage levels are among the main upside risks, alongside geopolitical disruptions to energy supply chains.

The Governing Council therefore continues to see risks to inflation as tilted to the upside. Although current evidence on wages, profit margins and inflation expectations remains relatively reassuring, the projected persistence of above-target inflation reinforces the need to monitor the duration and intensity of the energy shock.

Attention now turns to the September meeting, as new economic projections and additional inflation data should provide greater visibility, particularly after consumer prices ticked up in July. The ECB reiterates its data-dependent and meeting-by-meeting approach, making clear that the July pause does not signal the end of the tightening cycle, but equally that a September rate hike is not predetermined.

Markets remain firmly positioned for further tightening, pricing in a 96% chance of a 25-basis-point (bps) interest rate hike in September, according to the ECB Watch tool.

Market reaction

The Euro (EUR) shows little reaction to the release, with EUR/USD remaining under modest bearish pressure around 1.1640 on Thursday at the time of writing, down 0.08% on the day. Traders remain cautious ahead of Federal Reserve (Fed) Chair Kevin Warsh's speech at the Jackson Hole Symposium on Friday.