Market Pulse

Research evidence excerpt

Market Pulse

This would be the ECB’s first interest rate hike since 2023, when it decided to confront the inflation surge coming off of the

Russia-Ukraine War. Similarly to 2023, the ECB is facing a structural energy supply shock, which has accelerated inflation, as well

as higher medium-term inflation expectations.

Why a policy rate increase should look nearly a sure-thing today, however, goes back early May, when the Minutes from the April

ECB meeting revealed that keeping rates on hold at the April 30 meeting was, in fact, a very close call, with several policymakers

already wanting to hike back then. And since then, May's data has seen inflation rise further, even though the deviation from

the 2% target is nowhere near as pronounced as it is in the US. Core HICP (CPI) inflation, for example, climbed from 2.2% to

2.5% in May. Concurrently, services inflation rebounded sharply to 3.5%, revealing that price pressures were no longer confined

just to raw energy costs, although energy costs are likely the reason for the pervasive inflation increase.

What's probably just as important for the timing of the ECB's rate hike today, however, is that inflation expectations

have risen too, since April. According to the ECB Survey of Professional Forecasters (here), near-term inflation expectations for

2026 have been revised markedly upward, threatening to de-anchor from the 2% inflation target. The ECB has, in recent years,

been particularly sensitive to the premise that, if left unchecked, high inflation expectations will compel labor unions to demand

higher wage increases, allowing businesses to raise prices further to protect their profit margins.

Figure 1 - Euro Area: Multi-Year Inflation Projections from the ECB Survey of Professional Forecasters, Q1

and Q2 Surveys