ECB Rate Hike Expected as Eurozone Inflation Hits 3.3%

The European Central Bank (ECB) is expected to raise interest rates on Thursday for the second time this year, but economists are divided over why this move is necessary. Market odds suggest a quarter-point hike from 2.25% to 2.5%, which would be a relatively small increase.

The main reason for the rate hike is the high inflation rate in the eurozone, which reached 3.3% in August, up from 2.9% in July and the highest since September 2023. However, core inflation, which excludes energy and food prices, actually fell to 2.4% from 2.5%, suggesting that expensive energy is not feeding through into other parts of the economy.

ECB economists found that around 90% of the rise in energy inflation between January and May was due to adverse energy supply factors driven by geopolitical tensions. This is different from the previous surge in energy prices, which was caused by a combination of supply and demand-side factors.

The ECB's decision will also be influenced by the economic growth in the eurozone, which has been more resilient than expected. However, ING describes Thursday's expected move as 'another insurance rate hike', or 'a dovish rate hike,' noting that even at 2.5% the deposit rate sits within the range the ECB considers neutral.

The ECB is not acting alone, and its decision will be influenced by the actions of other central banks, including the Federal Reserve, which meets on September 15-16, and the Bank of Japan, which follows on September 17-18. If the Fed were to hike while the ECB held rates steady, it would likely strengthen the dollar against the euro, making imports dearer and pushing up energy costs.