Energy Is Pulling the ECB Back Into Inflation Mode. September Is Becoming the New Decision Point

For much of early summer, the European Central Bank looked as though it had regained control over the inflation cycle. Price growth was easing, core inflation was softening, and policymakers appeared increasingly confident that June's interest-rate increase might be enough to anchor expectations.

That confidence has weakened.

According to a Reuters survey of 74 economists, the ECB is expected to keep its deposit rate at 2.25% during its meeting on 23 July. None of the economists surveyed expects another immediate increase. The debate has shifted instead to September, when markets increasingly believe another hike may become necessary.

The reason lies far beyond Frankfurt.

Energy has returned as Europe's inflation problem

The renewed escalation of conflict in the Middle East has pushed oil prices roughly 20% higher in recent weeks, reviving fears that Europe's disinflation process may stall before reaching the ECB's 2% target.

Unlike previous inflation waves driven by pandemic supply disruptions, today's pressure originates from geopolitical uncertainty affecting global energy markets. That distinction matters because energy shocks tend to spread gradually through the economy rather than disappearing quickly.

Higher fuel costs eventually feed into transport, manufacturing, logistics and food prices. If companies begin passing those costs to consumers while workers demand higher wages to offset living expenses, inflation can become entrenched even if the original energy shock fades. Economists refer to these spillovers as "second-round effects"—precisely the scenario central bankers are trying to prevent.

The ECB's dilemma has returned

The problem facing the ECB is familiar but no less difficult.

Headline eurozone inflation slowed to 2.8% in June, continuing its downward trend. Core inflation has also moderated, suggesting domestic price pressures are easing. Under normal circumstances, those figures would strengthen the argument for patience.

Economic growth tells a similar story. Eurozone output expanded by only 0.2% last quarter, while economists have repeatedly downgraded growth forecasts for 2026. Higher borrowing costs risk weakening investment and consumer demand even further.

But monetary policy rarely responds to today's inflation alone.

Central banks are expected to anticipate where prices will move several quarters ahead. If energy costs continue rising through late summer, waiting too long could force more aggressive tightening later—an outcome policymakers would prefer to avoid.

That explains why nearly 70% of economists surveyed by Reuters now expect at least one additional ECB rate increase before the end of 2026, despite the expected July pause.

Markets are already looking beyond July

Financial markets increasingly view next week's meeting less as a policy decision than as a communication exercise.

Investors will watch closely for any indication that ECB President Christine Lagarde acknowledges the changing inflation risks created by energy markets. Even without raising rates, a more cautious—or hawkish—tone could reinforce expectations that September remains firmly on the table.

For European businesses and households, the implications extend beyond monetary policy itself.

Another rate increase would keep financing costs elevated for mortgages, business loans and corporate investment. At the same time, failing to respond if inflation accelerates again risks prolonging the broader cost-of-living pressures that central banks have spent several years trying to contain.

The ECB therefore faces a challenge that has become increasingly common in recent years: domestic inflation may be easing, but global geopolitics continues to reshape Europe's economic outlook.

The July meeting may produce no change in interest rates. It is increasingly likely, however, to define the conditions under which September becomes far more consequential.

Sources: Reuters, Financial Times