Global Market: ECB seen raising rates as Iran war fuels inflation fears

The European Central Bank is widely expected to raise interest rates for the second time this year on Thursday as it seeks to contain a fresh inflationary shock triggered by soaring energy prices amid the Iran war, Reuters reported.

Escalating attacks since the end of August have ended a period of relative calm, with the United States and Iran striking military, shipping and energy infrastructure. The conflict has pushed oil and gas prices sharply higher, renewing concerns over a broader wave of price increases across the fuel-importing euro zone, Reuters said in a report.

Economists expect the ECB to lift its policy rate to 2.50% from 2.25%, while signalling that further tightening could follow if the inflation outlook deteriorates. Reuters reported that markets are already pricing in another two or three rate increases by the end of next year.


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The ECB's decision comes as inflation remains above its 2% target, while the latest energy-price surge risks delaying a return to price stability. Brent crude touched $100 a barrel on Wednesday, although the latest jump in energy prices is unlikely to be fully reflected in the ECB's new economic projections.

Resilient economy offers ECB room to tighten

The euro zone economy has shown greater resilience than expected despite higher energy costs, competition from China and the effects of droughts.

Bank lending also accelerated in July, indicating that the ECB's June rate increase had yet to significantly weigh on economic activity. That could give policymakers additional room to tighten monetary policy if inflationary pressures persist.

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Long-term bond yields have also risen to levels not seen since before the global financial crisis, reflecting concerns over inflation and rising government debt. Aggressive borrowing by large technology companies to finance artificial intelligence investments, along with political uncertainty in Germany, has added to pressure on bond markets, Reuters reported.

ECB expected to revise growth outlook

The ECB is expected to raise its growth projections for this year and potentially for 2027, reflecting the stronger-than-anticipated performance of the euro zone economy.

At the same time, policymakers could push back their forecast for inflation to return to the 2% target. Inflation is currently above 3%, while the ECB had previously expected price growth to return to target by next summer.

Economists cited by Reuters have warned that higher fuel costs, trade tensions and weather-related disruptions could generate another inflationary wave. That could increase the likelihood of further ECB rate hikes in October and December.

Inflation pressures remain a concern

Several of the ECB's closely watched indicators have so far remained relatively contained. Core inflation, which excludes volatile energy and food prices, eased to 2.4% last month, while consumer inflation expectations declined and wage growth moderated.

However, analysts at Barclays have warned that underlying inflation pressures may be strengthening. Core goods prices have gained momentum, while producer prices are increasing considerably faster than consumer prices, potentially creating a stronger base for inflation in the coming quarters.

Companies, particularly in Germany, have so far absorbed much of the increase in costs rather than passing them directly on to consumers, according to ING's assessment reported by Reuters. That contrasts with the situation in 2022, when the energy shock following Russia's invasion of Ukraine triggered a much broader surge in inflation.

Lagarde's future could draw attention

ECB President Christine Lagarde is also likely to face questions about her future at the central bank during her post-decision press conference.

Her current term runs until October 31, 2027, but she has repeatedly been linked with a potential leadership role at the World Economic Forum. She also indicated earlier this year that she wanted to promote European values in some capacity during the campaign for next year's French presidential election.

Lagarde has previously rejected suggestions that she could leave the ECB before the end of her term.

A recent report suggesting that ECB board member Isabel Schnabel could join the International Monetary Fund has also fuelled speculation about a possible reshuffle among the euro zone central bank's senior leadership.

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