ING expects the European Central Bank to raise interest rates by 25 basis points at its next meeting, which would mark the ECB’s second rate hike of the year.
The expected move comes as policymakers try to balance persistent inflation pressures against signs that the eurozone economy remains more resilient than many had anticipated.
ING Sees Stronger Case for an ECB Rate Hike
Carsten Brzeski, global head of macro research at ING, said the argument for another ECB rate hike has become stronger since July.
At that time, some members of the Governing Council were already calling for tighter monetary policy.
Since then, the eurozone economy has performed better than expected despite the economic effects of the war in the Middle East.
Brzeski said part of that resilience has come from European companies gaining orders after Asian competitors were affected by the closure of the Strait of Hormuz.
Long-planned fiscal stimulus has also helped support economic activity.
Inflation Remains a Key Concern for the ECB
Headline inflation in the eurozone has continued to rise and is expected to remain above 3% year-on-year for the rest of the year.
However, core inflation and services inflation have not yet reached levels that would suggest an immediate inflation crisis.
Even so, elevated oil prices and the growing risk of another gas price shock are increasing pressure on the ECB.
Brzeski said these conditions make it increasingly difficult for policymakers to ignore the case for another rate increase.
ECB Forecasts Could Be Revised Higher
The ECB is also expected to release a new round of economic projections.
ING does not expect major changes to the central bank’s forecasts.
However, Brzeski believes both growth and inflation estimates could be revised slightly higher.
The expected revisions would mainly reflect stronger-than-previously-estimated first-quarter growth and the impact of higher oil prices.
Will the ECB Continue Hiking After September?
While another rate hike appears increasingly likely, the outlook beyond September is less certain.
Financial markets have started pricing in at least one additional interest rate increase before the end of the year.
At the same time, opinions within the ECB appear to be becoming more divided.
Officials including Isabel Schnabel and Irish central bank governor Gabriel Makhlouf have indicated that they may support additional tightening if inflation remains elevated.
ECB Rates May Still Be Near Neutral Territory
Following a 25-basis-point increase, the ECB deposit rate would rise to 2.5%.
According to Brzeski, that level would still fall within the range the ECB itself considers broadly neutral.
However, further rate hikes beyond that point would suggest that policymakers believe genuinely restrictive monetary policy is necessary.
Brzeski argued that there is an important distinction between an economy that is simply resilient and one that is overheating.
In his view, the eurozone has not yet reached a point where aggressive restrictive policy is clearly justified.
Higher Rates Could Increase Recession Risks
Concerns over public finances and rising government bond yields could make the ECB more cautious about extending its hiking cycle.
Brzeski questioned whether policymakers would be willing to increase borrowing costs even further at a time when financial conditions are already tightening.
He also argued that the eurozone is still dealing mainly with a supply-driven inflation shock rather than excessive domestic demand.
That makes the risk of pushing the economy into recession particularly important.
If the ECB raises rates too aggressively, it could weaken growth without fully solving inflation caused by energy and supply disruptions.
Rising Bond Yields Add Pressure on the ECB
The recent rise in eurozone bond yields is also expected to play an important role in the ECB’s discussions.
Higher yields naturally tighten financing conditions by making borrowing more expensive for governments, companies and households.
In that sense, bond markets are already doing part of the ECB’s job.
However, Brzeski warned that excessive increases in borrowing costs could create new problems.
The risk is especially significant if financing conditions tighten unevenly across different eurozone economies.
Debt Sustainability Is Becoming a Bigger Issue
Looking further ahead, debt sustainability is becoming another major concern for European policymakers.
Investors are paying closer attention to the ability of heavily indebted eurozone countries to manage higher borrowing costs.
France is likely to attract particular attention ahead of its next presidential election.
Higher bond yields combined with political uncertainty could increase pressure on government finances and financial markets.
ECB Leadership Questions Are Also Emerging
Market participants are also beginning to discuss the future leadership of the European Central Bank.
Early speculation has already started over who could eventually succeed ECB President Christine Lagarde.
Although that transition is still some distance away, expectations around future ECB leadership could influence longer-term views on monetary policy.
ECB Faces a Difficult Balance Between Inflation and Growth
The ECB now faces a difficult decision.
Inflation remains above target, energy risks remain elevated and the economy has shown surprising resilience.
At the same time, rising bond yields, weaker public finances and recession risks could limit how far the central bank is willing to tighten policy.
A 25-basis-point rate hike may therefore be relatively straightforward.
The bigger question is whether the ECB will continue raising rates after that without creating additional pressure across European financial markets.
