ECB Set to Hike Rates Thursday as Energy-Driven Inflation Hits 3.3%, Core Pressures Ease

The European Central Bank will almost certainly raise its key interest rate by a quarter-point to 2.5% when it concludes its two-day meeting on Thursday, as energy costs from the prolonged Iran conflict push eurozone inflation to its highest level in nearly three years.

Futures markets price a 99.7% probability of a 25-basis-point hike to the deposit rate, according to data cited by MarketWatch. The move would lift the rate from 2.25%, where it has sat since the ECB’s first rate increase in three years on June 11, followed by a hold in July.

August inflation figures removed any doubt. Eurozone headline inflation hit 3.3%, up from 2.9% in July and the highest since September 2023, driven by energy inflation that surged to 14.3% from 10.3%, several sources reported. European gas prices have reached their highest since early 2023, and Brent crude has risen over the past month, the Cyprus Mail and RTE.ie noted, both citing Reuters sources.

**‘Insurance’ Rather Than Restriction**

Beneath the headline, the inflation picture is more nuanced. Core inflation, which strips out energy, food, alcohol and tobacco, actually fell to 2.4% from 2.5%, according to Euronews. Services inflation, the component most closely tied to wages and domestic demand, dropped to 3% from 3.3%.

That divergence has led economists to describe the expected move as an “insurance rate hike” or a “dovish rate hike.” Carsten Brzeski, global head of macro at ING, was quoted by multiple outlets: “Another insurance rate hike … Or for those who don’t like this term: a dovish rate hike.”

The ECB’s own research supports the view that this inflation is supply-driven. In a paper published Tuesday, ECB economists found that adverse energy supply factors, driven by geopolitical tensions, accounted for around 90% of the rise in energy inflation between January and May, Euronews reported.

The national spread underscores the uneven impact. August inflation ran at 4.5% in Spain, 2.9% in Germany and 2.7% in France, three economies facing the same energy shock, all governed by one interest rate.

**Limited Appetite for Further Hikes**

Policymakers have little appetite to signal additional rate increases after this week, sources told Reuters as reported by the Cyprus Mail and RTE.ie. Traders still anticipate a high chance of another move by December and one more next year, again reflecting energy costs, but most economists polled by Reuters believe the ECB will be done after September.

“The hot topics for investors will be comments about indirect (inflation) effects and second round effects, how intensely and with what time delay energy prices will eventually translate into core inflation,” said Commerzbank economist Marco Wagner, as quoted by both outlets. “There is a lot of uncertainty around that.”

ING’s economists told clients in a note Tuesday that ECB President Christine Lagarde will likely keep her options open and push back against the current bond-market consensus that there will be another three quarter-point increases by June 2027, MarketWatch reported.

**Bond Yields and Other Central Banks**

Rising global bond yields are doing some of the ECB’s work by tightening financial conditions. Ten-year borrowing costs in France and Italy are up around 65 basis points this year, while Germany’s have climbed 50 basis points, the Cyprus Mail and RTE.ie reported, citing State Street macro strategist Michael Metcalfe.

“The ECB is always careful in how it talks about long-dated bonds and is likely to stress that only if the moves are out of line with the fundamentals are they likely to act,” Metcalfe said. “That doesn’t seem to be the case.”

The ECB is not moving in isolation. The Federal Reserve meets on September 15-16, with Chair Kevin Warsh having used his first Jackson Hole address to argue that financial conditions are not restrictive, according to Euronews. Investors now price a 60% chance the Fed hikes its target range from 3.5%-3.75% to 3.75%-4%. The Bank of Japan follows on September 17-18, with markets pricing an 80% to 90% chance of a move to 1.25%. By contrast, the Bank of England is expected to hold rates at 3.75% on September 17.

If the Fed hikes while the ECB holds, the dollar would strengthen against the euro. A weaker euro makes imports dearer, pushing up the energy costs driving the inflation problem, Euronews noted.

**No Heads-Up on Yen Intervention**

European central bankers were annoyed that the U.S. did not give them a customary heads-up that sales of euros, not dollars, were part of a recent yen-bolstering intervention, sources told Reuters, as reported by the Cyprus Mail and RTE.ie. Barclays head of euro rates strategy Rohan Khanna said the grievance was about being “blindsided.”

**Outlook**

Economists expect the ECB’s new projections due Thursday to leave inflation and growth forecasts broadly unchanged, though some anticipate GDP estimates could be nudged higher. SEB macro economist Pia Fromlet was quoted by both outlets as saying, “The ECB will probably revise up their 2026 growth forecast slightly.”

While high gas and oil prices keep upward pressure on inflation, eurozone business activity continues to post solid growth, matching the fastest pace this year, S&P Global data for August showed.

The deposit rate at 2.5% still sits within the range the ECB itself considers neutral, ING noted. Going further would mean deciding restrictive policy is required — a different judgement entirely. The dilemma remains: raising borrowing costs against an inflation the ECB cannot fully reach, while withdrawing support the economy could still use.