ECB Set to Raise Rate to 2.50% With Focus on Lagarde's Guidance

A 25-basis-point increase to the deposit rate, bringing it to 2.50%, is broadly anticipated from the European Central Bank today. Markets have already fully discounted this step. Since the decision is not expected to generate significant market movement, attention will turn to President Lagarde's press briefing.

This meeting takes place amid a challenging environment for the Governing Council. Annual inflation in the euro area accelerated to 3.3% in August, and energy costs have surged due to geopolitical strains and disruptions in the Strait of Hormuz. European gas prices recently hit their highest point since 2022, and the Iran war shows no signs of ending quickly. Meanwhile, core and services inflation have been easing, and economic activity has held up better than forecast.

The 25bp move will place the deposit rate at the top of the ECB's estimated neutral zone. Consequently, this meeting is critical in assessing whether the central bank sees 2.50% as enough to address the current economic shock, or if additional tightening into restrictive terrain is necessary.

Investment banks generally view September as marking either the conclusion of the tightening cycle or being near its end. No institution forecasts the ECB to make a firm commitment to an additional rate increase, though many note the risks tilt toward further action if energy prices stay high or price pressures become more widespread.

Little change to the statement, with data dependence to remain central

Analysts widely agree that the Governing Council will avoid major alterations to its policy statement. The ECB is set to stick with its meeting-by-meeting and data-dependent strategy, especially in light of the exceptional uncertainty over energy costs and the geopolitical situation.

The assessment of the economy is also unlikely to shift meaningfully. Growth has held up better than forecast, while inflation remains above target and energy prices present a renewed upside risk. The balance of risks will thus stay broadly similar: downside risks to growth and upside risks to inflation.

Lagarde's press conference will be more important than the statement

President Lagarde's press conference is expected to carry greater weight than the formal statement. The prevailing view is that she will refrain from giving specific signals about the next rate decision, stressing instead that forthcoming moves will hinge on economic data. This pattern aligns with the ECB’s recent communication approach.

Yet the tone of her remarks matters. If Lagarde adopts a hawkish stance, she might highlight the enduring nature of the energy shock, the danger that inflation stays above goal for an extended period, and the scope for additional rate increases.

Conversely, if she underscores the deceleration in core and services inflation, the risk of over-tightening, and the effect of elevated rates on already stretched financial conditions, the tone would appear more dovish.

Economic projections to show stronger growth, but a more complicated inflation outlook

The updated macroeconomic projections are expected to reveal stronger growth figures but a more intricate inflation picture.

The ECB's updated forecasts likely include higher growth numbers, mirroring the euro area’s better-than-anticipated performance.

The inflation forecasts are more nuanced. According to Goldman Sachs, the 2026 headline and core inflation estimates will likely be cut by 0.1 percentage points, given inflation readings have come in below the ECB's earlier projections. Nonetheless, the 2027 headline inflation projection is seen increasing by 0.4 percentage points to 2.7%, and core inflation by 0.1 percentage points to 2.6%. This is mainly due to the energy shock: elevated spot and forward energy costs indicate inflation may stay above the target for a longer duration than initially anticipated.

UniCredit also forecasts a hawkish shift in the inflation forecasts, notably via an upward revision to next year's inflation view and a postponed return to the 2% target.

MUFG takes a less worried view of the forecasts. It suggests the 2026 headline inflation estimate might actually be decreased after the recent inflation undershoot, but cautions that the projections could be outdated as the technical cut-off date probably occurred before the latest spike in natural gas costs.

The ECB's baseline estimates might not completely incorporate the newest energy price shock. Hence, Lagarde's remarks carry greater significance for market reaction.

Consensus summary

• A 25bp increase to 2.50% today.
• The move is already priced in, so it will not affect markets.
• The ECB will maintain its data-dependent, meeting-by-meeting stance.
• Lagarde is not expected to make a clear commitment to another hike.
• Growth projections are expected to be raised broadly.
• Energy costs pose a notable upside risk to inflation.
• Core and services inflation are still much less worrying than the headline figure.
• Further rate hikes are possible, but the ECB probably will not strongly signal them now.
• The September increase is expected to conclude the current tightening cycle, or at least its initial phase.

Market pricing

Markets now price in approximately 48 basis points of tightening by the end of this year and 85 basis points by the close of 2027. That implies traders anticipate at least three rate rises by December 2027, including today's increment.

This represents substantial tightening already reflected in the yield curve. As a result, downside risks prevail for the euro, because the ECB must surpass market expectations to spark a hawkish re-evaluation and support the single currency.

A 25bp rise combined with a cautious Lagarde would likely be interpreted as more dovish, putting pressure on the euro as rate hike expectations diminish. Conversely, if Lagarde stresses the ECB's readiness to keep raising rates if inflation risks endure, the euro might gain, indicating greater appetite for additional tightening.

In short, given that the market already prices an aggressive tightening trajectory, the threshold for the ECB to spring a hawkish surprise is elevated.

Summary

The ECB will almost certainly proceed with a 25bp increase today, rendering the decision itself mostly inconsequential for markets. Attention will centre on forward guidance. The consensus indicates upward revisions to growth estimates, a more intricate inflation picture due to the energy crisis, and ongoing data-dependent phrasing from Lagarde.

The primary point of contention is the outlook beyond this meeting. MUFG and ING favour September as the cycle's end, whereas Goldman, Wells Fargo and UniCredit perceive a clear risk of additional tightening should energy costs stay elevated or inflation become more widespread.

For markets, however, the key takeaway is that the hurdle for a hawkish surprise is already significant. With roughly 48bps of rate increases expected by year-end and 85bps by the end of 2027, the ECB must surpass market pricing rather than merely sound hawkish to trigger a substantial euro-positive movement.

And even if it manages to do so, any euro rally might be susceptible to a reversal because focus will soon turn to the US consumer price index report and the Federal Reserve's decision, where alterations in the Fed's anticipated rate path could again dominate EUR/USD.