Euro Area: More arguments for a hike than a hold by ECB in September

Danske Research Team Danske Bank A/S

The September ECB meeting is priced as a close call, with markets seeing even odds of a hike versus a hold. Weighing the arguments, we think the case for a second 25bp hike slightly outweighs the case for unchanged rates. Hence, we assign a 60% probability to a 25bp hike in September (our baseline) and 40% to no change. In the latter case, we expect the deposit rate to remain at 2.25% until end-2027.

Arguments for a hold in September

1. Inflation has surprised to the downside, and oil price has collapsed, with June inflation below expectations on a broad-based decline beyond energy. Core inflation fell to 2.4% y/y, goods inflation remained weak, and food prices declined for a second month. This suggests the energy shock has not generated indirect effects so far, possibly reflecting weak demand and limited pass-through. Inflation thus averaged 3.0% y/y in Q2 versus the ECB staff projection of 3.2%. Importantly for the inflation outlook, crude oil futures have fallen more than expected and are now well below the ECB’s “milder” scenario in near-term contracts.

2. Selling price expectations declined again in June, with services back to February levels and PMI output prices close to pre-war levels. Industry, construction and retail expectations remain elevated, but services matter most for the ECB’s concern about second-round effects.

3. Growth has been weaker than expected. The ECB staff projected GDP growth at 0.2% q/q in Q2, but the composite PMI averaged only 49.1. Longer delivery times likely overstates manufacturing strength, suggesting both growth and inflation forecasts may be revised lower in September.

4. There are no signs of significant second-round effects in inflation expectations, wages or pricing dynamics. The ECB wage tracker still points lower, and recent labour-market data have softened, which should dampen wage demands despite low unemployment.

5. Recent ECB communication has turned more balanced. Lagarde noted at Sintra that risks to inflation and growth are now more balanced, Stournaras said further hikes are less likely, and Kazaks said the ECB could stop if conditions improve.

Arguments for a hike in September

The Governing Council bias remains hawkish even as it is slightly more balanced now. Schnabel, Kaasik, Wunsch and Nagel have all signalled that another hike remains possible or reasonable, with Nagel stressing that it is too early to conclude that second-round effects are over. Lane also remains quite positive on European growth while Lagarde is defending the June hike strongly.

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Danske Research Team

Danske Bank A/S

Research is part of Danske Bank Markets and operate as Danske Bank's research department. The department monitors financial markets and economic trends of relevance to Danske Bank Markets and its clients.

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