The European Central Bank saw some encouraging signs on inflation at its July meeting, but policymakers remained concerned that the energy shock from the Middle East could keep price pressures elevated longer than expected.
Why it matters: Euro-area inflation fell to 2.8% in June from 3.2% in May, with energy, food, goods and services inflation all declining. Underlying inflation pressures also moderated, while wage growth showed signs of easing.
- But ECB officials warned against taking too much comfort from the improvement because much of it came from volatile energy and food prices that could quickly reverse.
Energy remains the biggest concern. Oil prices were 6% lower than at the June meeting, but European natural gas prices had jumped 16%, while longer-dated oil prices remained elevated. The ECB concluded that energy prices remained well above pre-war levels and that risks were still tilted toward higher inflation and weaker economic growth.
- Policymakers also noted that higher energy costs had not yet fully worked their way through the economy.
- Elevated natural gas prices could eventually push electricity and core inflation higher, while higher transportation and agricultural costs, along with heatwaves and the possibility of El Niño, could put renewed upward pressure on food prices.
Decision, But: The ECB ultimately left rates unchanged in July, arguing that it could wait for additional inflation, wage and economic data before its September meeting. However, policymakers made clear that the pause should not be interpreted as the end of the tightening cycle, saying another rate hike would likely be necessary unless the inflation outlook improves significantly.
The bottom line: Inflation is moving in the right direction, but the ECB isn’t ready to declare victory. With energy markets still vulnerable to the Iran war and broader inflation risks tilted to the upside, another rate hike remains firmly on the table.