Euro area: Well above target inflation, while the ECB sounds ready to hike

The combination of today’s (1 September) inflation data, rising energy prices and hawkish European Central Bank (ECB) commentary leaves us now expecting a hike at next week’s ECB meeting. A hike will be no surprise to markets, but President Christine Lagarde’s comments will be closely watched for insights into the path beyond September where markets are priced for almost two further hikes in 2027.

With headline inflation well above target and energy prices rising again, it makes sense to expect the ECB to raise rates in September rather than remain on hold to help mitigate inflation risks.

As expected, euro area CPI rose to 3.3% year-on-year in August after 2.9% year-on-year in July. While details are limited in the flash estimate, the increase in inflation was mostly driven by energy prices, which increased 2.9% on the month. Signs of the impact of energy inflation broadening out were reassuringly limited, but not absent. core inflation fell a tenth to 2.4% year-on-year (cons.: 2.5% year-on-year) and services inflation fell from 3.3% year-on-year to 3.0%. However, core goods inflation rose. 

While today’s inflation data will likely give policymakers some reassurance around the risk of inflation persistence, there is plenty here for the hawks too. With headline inflation well above target and energy prices rising again, it makes sense to expect the ECB to raise rates in September rather than remain on hold to help mitigate inflation risks.

Hinting at a hike

The market is fully priced for a rate hike at the September ECB meeting next week (10th September).

Oil prices are currently lower than in the baseline scenario, but they have been rising over the past month.

Alongside already well above target inflation, European natural gas prices (€71 per MWh at the time of writing) are now higher than the peak incorporated into the ECB’s adverse scenario (€60 per MWh) from their June forecasts, and forward-looking futures prices now sit in-between the baseline and adverse scenario. Oil prices are currently lower than in the baseline scenario, but they have been rising over the past month.

Activity data, meanwhile, has been pointing to a relatively resilient growth backdrop, further lowering the bar to a rate rise. Q2 GDP was stronger than expected, rising 0.4% quarter-on-quarter (cons.: 0.2% quarter-on-quarter). The latest flash PMIs pointed to further activity growth in August, with the composite PMI at 52.1. This has also been reflected in other survey data, with the European Commission economic confidence indicator and the German Ifo survey, for example, showing improvement. 

Business surveys have been particularly strong in Germany following government tax cuts and stronger defence spending announced at the start of July. The euro area unemployment rate, meanwhile, has remained at relatively low levels and loan growth (to businesses and households) has been robust.

A hawkish tone

We have heard from fewer ECB speakers than usual since the July meeting, as the ECB has been in their summer quiet period. However, a number of policymakers have spoken over the past week, and the overall tone has leaned hawkish. 

• Isabel Schnabel said, “at the current policy rate, inflation is unlikely to return to target … therefore further tightening will be necessary.” She also said, “in the current environment of resilient aggregate demand, it is critical to prevent the occurrence of second-round effects early.”
• Dimitar Radev said, “September remains open, but based on what we know today, another measured step deserves serious consideration. Waiting until second round effects are fully visible could mean acting too late.”
• Martins Kazaks said that inflation must not be allowed to take root. “One way to reduce that inflation taking root is to raise interest rates. We’ve done that before.”
• Primoz Dolenc said, “The arguments are there for a hike in September to safeguard our inflation target. With the new data coming in, we see that the inflation situation doesn’t resolve itself.”
• Martin Kocher said, “The European economy is more resilient than many people think it is, showing some momentum now, more momentum.”
• Olli Rehn said, “We must show no complacency in the face of these inflationary pressures” and said that the market pricing for a hike in September was ‘understandable’.”

After the July meeting and press conference, we noted Lagarde’s comments were consistent with a hike in September if things stayed as they were. Since then, energy prices have remained elevated and headline inflation has reaccelerated once again in August, meaning a hike would not be a great surprise.

Taking this all into account, it makes sense to expect the ECB to hike rates 25bps to 2.50% next week. The ECB will also publish updated staff projections, which we expect will continue to include a range of scenarios. We will be paying close attention to those forecasts, as well as Lagarde’s press conference, for signals on how the ECB are thinking about the economic outlook, the risk of indirect and second-round effects and the potential for further rate hikes.

We are not currently pencilling in further hikes, but at this stage see a reasonable probability of one. Much will again depend on events in the Middle East and the incoming data as well as whether an energy price shock is followed by a food price shock (see The Next Inflation Storm? Food fertiliser and El Nino, July 2026). But we think that further hikes now, all else being equal, will increase the chance of rate cuts later in 2027.

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