The ECB's rate hike is almost a certainty! The real variable will be in December: Lagarde's future adds further policy uncertainty.

The European Central Bank's rate hike this week is a foregone conclusion, but what is truly affecting the market is the discrepancy between the intensified tightening and the turmoil in senior personnel. While the ECB continues to raise rates under pressure from inflation data, rumors about the future of President Lagarde and key hawkish executive member Isabel Schnabel are casting a shadow over the policy continuity of the Eurozone.

The eurozone inflation rate broke through 3% last month, reaching a near three-year high, driven by energy costs from the Iran war, completely shattering any remaining market hopes for a pause in interest rate hikes. The market expects the European Central Bank to raise its deposit rate by 25 basis points to 2.5% this Thursday, marking the second increase since the resumption of rate hikes in June, further solidifying its position as the most hawkish central bank among the G7.

A September rate hike is almost a certainty— all economists surveyed by Bloomberg, except for one analyst, expect deposit rates to rise to 2.5%. However, the path ahead is far from clear: the market expects two or more rate hikes after this one, while economists are generally skeptical, and there is significant disagreement within the Governing Council regarding whether to proceed with further action in December.

Meanwhile, speculation continues to intensify regarding Lagarde's potential early departure—rumors suggest she may succeed as chair of the World Economic Forum (WEF) or pursue a career in French domestic politics; core hawkish executive committee member Isabel Schnabel is also rumored to be considering a move to the International Monetary Fund (IMF). If either of these changes materializes, the hawkish influence and policy credibility will be weakened, and this round of interest rate hikes may become the "farewell rate hike" of the Lagarde era.

Inflation exceeding 3% forces interest rate hikes; G7's most hawkish central bank leads the way again.

The immediate driver of this interest rate hike is persistent inflation. Last month, the Eurozone's Consumer Price Index (CPI) rose by more than 3% year-on-year, reaching a near three-year high. The energy component surged sharply, driven by the war in Iran, and is unlikely to decline significantly in the short term. European Central Bank officials are battling this near three-year high in price increases.

The market has already priced this in. A Bloomberg survey shows that all but one analyst expect deposit rates to rise by 25 basis points to 2.5%. New quarterly economic forecasts will support the action: analysts expect the ECB to raise its inflation forecast for next year (from 2.3% in June), keep its 2026 inflation forecast unchanged at 3%, and raise its economic growth forecast—the 21-nation eurozone economy has shown unexpected resilience.

Unlike its peers, such as the Federal Reserve and the Bank of England, which remained on hold, the European Central Bank (ECB) raised interest rates in June, making this week's move virtually uncontroversial. This meeting was unusually held outside its Frankfurt headquarters, with the policy statement scheduled for release at 2:15 PM Berlin time, followed by a press conference by Lagarde 30 minutes later. This rate hike will solidify the ECB's position as the most hawkish central bank in the G7.

The path forward in December is fraught with disagreement, with conflicting opinions within the management committee.

The suspense centers on what happens after September. The market currently expects two or more rate hikes following this one, but most economists are skeptical. The European Central Bank's Governing Council is also divided: some officials believe interest rates may need to be raised further after this month, while others are urging caution, arguing that there is no double-dip inflation effect and that the situation in the Middle East and US trade policy still pose risks.

“The ECB will obviously raise rates this week,” said Jari Stehn, chief European economist at Goldman Sachs. “But there is huge uncertainty about the outlook, and some signs of division within the Governing Council mean they are likely to remain completely open to the rate outlook.” ING economist Marieke Blom was more dovish, believing that current inflationary pressures are not as severe as they appear. “We believe one rate hike may be enough.”

The clash between hawks and doves was already evident. Gediminas Simkus, Governor of the Central Bank of Lithuania, stated that raising interest rates to 2.5% was insufficient to bring inflation back to the 2% target, citing reasons including stronger economic growth. Executive Board member Piero Cipollone, however, warned that the ECB should adopt a "well-calibrated" policy to avoid harming the economy. 2.5% is widely considered the upper limit of the neutral range; above this level, economic activity would be suppressed, but not everyone agrees with this assessment.

David Powell and Simona Delle Chiaie of Bloomberg Economics point out that against the backdrop of renewed volatility in the oil market and soaring natural gas prices, hawks will undoubtedly push for another rate hike in December, but tightening financial conditions and signs that the indirect effects of the energy shock are limited pose significant obstacles. Bundesbank President Joachim Nagel cautions that officials must also consider the recent rise in global bond yields, which "further complicates the situation."

Personnel turmoil coupled with policy continuity is putting it to the test.

Even more difficult to price than differing paths is the future of the European Central Bank's top leadership. Speculation about Lagarde's early departure is intensifying, and her remarks after the July policy meeting have been the clearest signal to date—she will not serve her full term until October 2027. Bloomberg reported last month that the World Economic Forum, known for its Davos annual meeting, is still vying for her successor, and Lagarde, who will publish her memoirs at the end of January, seems prepared to accept the position.

Lagarde has recently not ruled out playing a role in French politics, stating, "Whatever role I play, I will be the most effective." Following her trip to Berlin, she will be the guest of honor at the annual political rally organized by Hervé Morin, the president of the Normandy region and leader of a centrist party.

If Executive Board member Isabel Schnabel leaves her post early, the pressure on Lagarde to clarify her future plans may increase further. The German official's term ends in 2027, and she may move to the International Monetary Fund. Schnabel's departure will directly weaken the hawkish voices within the Governing Board and shift the balance of future crucial votes.

For the market, this week's rate hike is no longer the only focus. As data-driven tightening proceeds as scheduled, investors also need to reassess the credibility of post-Lagarde policy – this will determine whether the Eurozone interest rate path can be priced in as clearly as it has in recent months.

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