Cooling inflation and plunging oil prices shatter rate hike consensus; internal divisions within the ECB may make September a policy watershed

There is no longer a consensus within the European Central Bank regarding the next step in policy tightening. The rapid decline in oil prices and cooling inflation in the eurozone are weakening the urgency for further rate hikes and prompting the market to reassess the outlook for rates within the year.

According to Bloomberg, noticeable divisions among ECB officials have emerged during the annual forum held recently in Sintra, Portugal, on whether further rate hikes are necessary to bring inflation back to the 2% target. Some officials believe that inflation pressures triggered by conflict are still being transmitted and may appear later through wages, food, and services prices.

Another group of officials argue that as peace efforts make progress and oil prices fall back to pre-war levels, severe second-round inflation effects may not materialize. The significant drop in eurozone inflation in June also supports this view.

The market generally expects that the likelihood of major policy adjustments at the July rate-setting meeting is extremely low; holding steady has become the consensus. But with more wage data set to be released before the September meeting, the probability of intensified divisions will notably increase by then.

Dovish Camp: Limited Second-Round Risk, Data Support Cooling Inflation

Several officials have publicly expressed the view that inflation risks are easing. Bank of Finland Governor Olli Rehn said in an interview that he does not expect any major second-round effects, meaning his support for further rate hikes is limited.

Austrian central bank governor Martin Kocher stated in another interview that the inflation threat has "clearly diminished, at least in the short term."

Governing Council members Primoz Dolenc from Slovenia and Martins Kazaks from Latvia both said there is no need to act in July; Belgian central bank governor Pierre Wunsch hinted there may be no reason to raise rates again at all.

Eurozone inflation in June was 2.8%, a clear slowdown from May’s 3.2% increase and below the 3% median expected by economists in a Bloomberg survey. The core inflation measure, which excludes volatile food and energy items, as well as the closely watched services inflation indicator, also both declined.

This shift is largely due to oil prices dropping to pre-war levels and being significantly lower than the ECB’s assumptions made in last month’s forecast. Under that earlier projection, inflation was expected to remain above the 2% target until 2027.

Hawkish Camp: Vigilance Against Inflation Rebound

Meanwhile, the hawkish camp led by Lane remains cautious. As a key figure in making policy recommendations to colleagues, Lane emphasized that officials are committed to not "locking themselves into" any predetermined rate path.

Bundesbank President Joachim Nagel echoed this stance, although he admitted the decline in oil prices was indeed unexpected.

Estonian central bank governor Ulo Kaasik said in an interview that he considers at least one more rate hike to be "reasonable," while Bank of Greece governor Yannis Stournaras said in a separate interview that, given the current situation, "perhaps maintaining the status quo for a while would be better." These two comments are seen as representative of the extremes in this round of debate.

ECB President Lagarde: Risks Now More Balanced

ECB President Christine Lagarde acknowledged in the closing panel discussion of the Sintra forum that the situation has changed rapidly in recent times. The session also featured Federal Reserve Chair Jerome Powell.

She stated that, given the fast-evolving circumstances, the upside risks to inflation and downside risks to growth "may now be more balanced than a few weeks ago."

Wage Data as a Variable, September Meeting Could Be a Key Juncture

Analysts believe that, despite some easing in current inflationary pressures, the lag in wage data reporting means the market still has to wait for a clearer basis of judgment. If the previously fast inflation rate has triggered higher wage demands, price pressures could become further entrenched and persist longer.

Bloomberg Economics Chief Eurozone Economist Simona Delle Chiaie said that an improved economic outlook could widen divisions within the Governing Council, as the urgency for further hikes is fading. She noted that while their base forecast still expects one final rate hike this year, the downside risks to that view are becoming more pronounced.

With more economic data to be released before the September meeting, the debate within the ECB over the rate hike trajectory is expected to intensify, making it a key window for observing eurozone monetary policy trends for the rest of the year.