Markets 'too aggressive' on further ECB hikes as lagarde keeps options open

While we think that the ECB can probably justify another insurance hike this month, we also see clear arguments against it. Underlying inflation has softened, second round effects remain absent and wage pressures are limited.

But the longer the conflict runs, the greater the risk of inflation spreading, and the tougher the ECB’s position becomes, so we suspect that the Governing Council will lean towards hiking regardless.

Investors will be looking for signals in Lagarde's rhetoric that could hint at the path ahead. If she notes that rates are at the top of the neutral range, this could be a signal that the bar for further hikes is high, whereas concern over second-round effects taking hold the longer the conflict runs would act to keep a December hike alive.

As things stand, markets are currently pricing in another hike in December, with an additional one seen coming in March. We think that this is too aggressive. The ECB's chief economist Philip Lane has pointed to 2.5% as the upper bound of the ECB's neutral-rate estimate, so any tightening beyond this month would tip policy into restrictive territory.

We instead expect September to be the last hike in this unusually short, two-step cycle. Of course, much still depends on how the Iran war evolves. A protracted stalemate or further flare-up in hostilities that triggers another meaningful spike in energy prices, or sizable second-round effects, could well embolden the hawks on the Governing Council to push for more.

Certainly, a sustained move in Brent crude above $100 a barrel - on top of already elevated gas prices - would raise the risk that headline inflation stays above 3% for longer than the ECB currently expects. At any rate, Lagarde is unlikely to shut the door entirely.