ECB Shifts to Hawkish Tone Amid Geopolitical Tensions

The European Central Bank (ECB) has adopted a more hawkish tone due to renewed geopolitical tensions and rising oil prices. After pausing in July, the ECB's September rate decision remains uncertain, depending on incoming data and developments.

Following the collapse of the preliminary agreement between the US and Iran regarding the Persian Gulf crisis, President Christine Lagarde noted that some members of the Governing Council expressed a preference to raise rates at this meeting. Although the decision not to do so was unanimous, this detail indicates a shift in balance towards higher interest rates.

Lagarde emphasized that the balance of risks to inflation remains tilted to the upside, and the ECB is concerned about elevated uncertainty in the global economy. The situation in the Middle East may be brought back under control, but new threats could emerge, such as the threatened closure of the Red Sea strait, which has acted as a buffer for oil prices.

The ECB will remain anchored in scenario planning to drive its decision-making, and if the Strait remains closed after the summer break, it will be difficult for the ECB not to raise rates again. Lagarde validated market expectations, which are currently pricing in at least one more rate hike as early as September.