Cooling inflation and plunging oil prices undermine rate hike consensus; internal divisions in the European Central Bank, September may become a policy watershed.

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There is no longer a unified stance within the European Central Bank regarding whether to continue tightening policy. 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 rate outlooks for the rest of the year.

According to Bloomberg, ECB officials displayed clear divisions during their annual forum in Sintra, Portugal, recently, regarding whether further rate hikes are needed to bring inflation back to the 2% target. Some officials believe that inflationary pressures triggered by conflict are still being transmitted and may show up later through wages, food, and service prices.

Other officials think that as peace efforts progress and oil prices return to pre-war levels, severe secondary inflation effects may not occur. The sharp fall in Eurozone inflation in June also supports this view.

The market widely expects that the likelihood of significant policy adjustments at the July policy meeting is very low, and holding rates unchanged has become consensus. However, as more wage data is released before the September meeting, the probability of escalating divergence by then is set to rise substantially.

Dovish Camp: Limited Secondary Effects, Data Supports Cooling Inflation

Several officials have publicly expressed views that inflation risks are easing. Finland's central bank governor Olli Rehn said in an interview that he does not expect any significant secondary effects, which also means limited support for further rate hikes.

Austria's central bank governor Martin Kocher said in another interview that the inflation threat has "clearly diminished, at least in the short term."

Governing Council members Primoz Dolenc (Slovenia) and Martins Kazaks (Latvia) both stated that there is no need to take action in July; Belgium’s central bank governor Pierre Wunsch even hinted that there may not be any reason for another rate hike at all.

Eurozone inflation rate in June was 2.8%, a clear slowdown from May’s 3.2%, and also lower than the 3% median expectation from Bloomberg economist surveys. Core inflation—excluding food and energy—as well as the closely watched service inflation index, also declined.

This change largely results from oil prices falling to pre-war levels, significantly lower than the assumptions used for ECB forecasts last month. According to those forecasts, inflation would remain above the 2% target until 2027.

Hawkish Camp: Beware of Inflation Rebound

Meanwhile, hawks led by Lane remain cautious. As a key figure who advises fellow Governing Council members on policy, Lane emphasized the commitment to "not lock themselves" into a fixed rate path.

German central bank governor Joachim Nagel echoed this stance, although he admitted oil price declines were "indeed unexpected."

Estonia’s central bank governor Ulo Kaasik said in an interview that he thinks at least one more rate hike is "reasonable," while Greece’s central bank governor Yannis Stournaras said in another interview that, under current conditions, "perhaps maintaining the status quo for a while would be better." These two statements are seen as representing the extremes of the current divergence.

ECB President Lagarde: Risks Are More Balanced

ECB President Christine Lagarde admitted in the closing panel of the Sintra forum that the recent situation has evolved rapidly. The discussion also included Fed Chair Jerome Powell.

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

Wage Data as a Variable, September Meeting Could Be Key Turning Point

Analysts note that although current inflation pressure has eased, the considerable lag in wage data reporting means the market needs to wait for clearer evidence. If the faster inflation in previous periods has led to higher wage demands, price pressures may become more entrenched and persist longer.

Bloomberg Economics Eurozone Chief Economist Simona Delle Chiaie said that improving economic prospects could widen internal divergence within the Governing Council, as the urgency for further rate hikes is diminishing. She said that although the baseline forecast still expects one final rate hike this year, the risks to that view are becoming more prominent.

As more economic data is released before the September meeting, debate within the ECB about the rate hike path is expected to intensify, making it a crucial observation window for Eurozone monetary policy in the second half of the year.

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