ECB Holds Rates Steady, But Tightening Looms as Tensions Rise

The European Central Bank (ECB) is set to hold its monetary policy meeting tonight, and while there's almost no suspense about keeping interest rates at 2.25%, what's really on everyone's mind is how much room the ECB will leave for further tightening in September and beyond.

Renewed US-Iran tensions have reignited expectations of tighter policy, with oil prices above $90 per barrel. Economists like Oliver Rakau believe that current data slightly favor further tightening, a stance consistent with the ECB's forecasts in June and market pricing.

The ECB has already priced in future actions, with traders expecting three rate hikes by February next year at the latest, and a 60% probability of another hike by mid-year. However, if the deposit rate rises to 2.5%, it could be considered 'moderately restrictive', making it easy to cut rates when inflation approaches target.

The ECB's confidence in pausing comes from the absence of long-feared 'second-round effects' so far, but they still expect them to materialize eventually. Meanwhile, extreme heat and El Niño may have damaged crops and pushed up future food prices.