The ECB, once again facing the dilemma: containing inflation without cooling the economy too much

BrusselsThe decision that makes families with a variable mortgage tremble is here again: the European Central Bank decides this Thursday whether to raise interest rates. And, taking into account that inflation in the eurozone has reached its highest level since the autumn of 2023, the consensus among experts is clear: the ECB is expected to raise them by a quarter of a percentage point, to 2.5%.

When making this decision, Frankfurt takes into account the evolution of prices, which have skyrocketed for almost three years due to the rise in energy costs following the closure of the Strait of Hormuz. Driven by this sector – which generates chain effects on the entire price structure – headline inflation has risen to 3.3%. Core inflation (which excludes the most volatile sectors, such as energy and food) remains stable and stands at around 2.4%, a figure close to the average of the last year and near the 2% target set by the ECB. With the interest rate hike, the monetary institution hopes to curb the rise in prices, since the more expensive money is, the more spending is reined in.

The body chaired by Christine Lagarde raised interest rates in June for the first time since September 2023. At the time, it justified the move due to the "great energy shock," which was lasting "longer than expected" and having an impact on prices. Afterwards, in July, the ECB opted for caution and decided to keep them steady to have room to "navigate the uncertainty caused by the conflict" in the Middle East. If the September hike is confirmed, rates will reach the maximum that the body considers neutral, 2.5%; that is, a level that does not impact economic growth.

The ECB is trying to strike a balance to avoid putting more pressure on an already fragile economy. The problem Frankfurt faces is that the current uptick in inflation has a cause on which interest rates have little power: the rising cost of energy. Prices are rising due to a supply shock: energy has become more expensive because the conflict has hindered its supply, not because the demand from families and businesses has skyrocketed.

And raising interest rates will not lower the price of oil. The ECB's action, therefore, aims to prevent the energy shock from spreading to the rest of the economy, but without cooling down further an activity that is already showing signs of weakness.

The vast majority of economists consulted by Reuters believe that 2.5% will be the end of this year's rate hike cycle and that the rate will remain there for a good part of 2027. However, Deutsche Bank already anticipates another hike in December, to 2.75%, precisely because the energy shock could be more persistent than expected.

The ECB will also publish new macroeconomic projections for inflation and growth, which will serve to calibrate the organization's reading of the economic situation. Reuters notes that an upward revision of inflation is expected, as well as higher growth. The Brent barrel (the benchmark indicator in Europe for measuring the price of oil) has reached 100 dollars again, and the price of gas is at its highest since 2023.

A united Europe

The president of the European Central Bank insisted on Wednesday on the need for a more united European Union "in a tougher and less forgiving world," increasingly conditioned by major powers. For Lagarde, the continent faces a dilemma "about who we are as Europeans," for which she sees three ways out. The first, to accept that Europe's decline is "inevitable." The second, for each country to pursue its own national economic interests. And the third, her proposal: "to choose each other and continue the task of building Europe."

"If we act together," she said, "we will be able to fully leverage our scale and be less vulnerable to external pressures. Then we will have more sovereignty and faster growth."