ECB's Schnabel pushes more hikes as inflation holds at 2.9%

European Central Bank board member Isabel Schnabel said rates must rise further, arguing inflation is unlikely to return to the 2 percent target as the Middle East conflict and a resilient eurozone economy pose upside risks.

"At the current policy rate, inflation is unlikely to return to target over the medium term, and therefore further tightening will be necessary," Schnabel told Bloomberg News in an interview published Wednesday.

The deposit facility rate stands at 2.25 percent after the ECB's first increase in almost three years in June. Euro-area inflation was 2.9 percent in July, up from 2.8 percent in June, with energy prices accelerating to 10 percent year on year. Money markets price about 40 basis points of additional tightening by year-end, with an 83 percent probability of a 25-basis-point hike at the September 10 Governing Council meeting.

A September move would lift the deposit rate to 2.50 percent, tightening financial conditions across the eurozone just as Germany's Ifo Business Climate Index hits a one-year high and second-quarter GDP growth is revised upward. The ECB must weigh whether the recovery can absorb higher borrowing costs against the risk that energy-driven inflation becomes entrenched.

Energy Costs and Second-Round Effects Drive the Hawkish Case

Schnabel's warning centers on the risk that high energy prices feed into wages and broader price-setting. Waiting until those costs pass through to pay deals would leave policymakers "behind the curve," she said, adding that the ECB needed to prevent second-round effects early. The natural gas situation was "particularly concerning," she said.

The front-month Dutch TTF contract, Europe's gas benchmark, closed above 68 euros per megawatt-hour on August 24 — its highest since January 2023 and more than double its level before the Iran war began. Prices have climbed about 120 percent since the start of the year, with the Strait of Hormuz still effectively closed and Norway extending outages at gas fields.

Euro-area core inflation, excluding energy and food, stood at 2.5 percent in July, while services inflation ran at 3.3 percent — both above the ECB's target. The last time the ECB faced a comparable energy-driven inflation shock was in 2022, when the deposit rate rose from -0.5 percent to 4 percent over 14 months before the Council began cutting in June 2024.

Three sources told Reuters on August 25 that policymakers were leaning toward another 25-basis-point increase in September to contain the inflationary impact of the Iran war, though there was little appetite to signal further tightening beyond that meeting. The ECB declined to comment on those reports.

Growth Data Complicates the Tightening Calculus

The hawkish case collides with a eurozone economy showing unexpected resilience. Euro-area output grew 0.4 percent in the second quarter — twice the rate economists had forecast — and 1 percent year on year. Germany's Ifo Business Climate Index climbed to 88.8 in August, its fourth consecutive monthly gain and the highest reading since August 2025, while the Federal Statistical Office revised second-quarter GDP growth upward to 0.3 percent from 0.2 percent.

The euro has strengthened 2.76 percent over the past month to near 1.1682 against the dollar, though it remains roughly 0.5 percent lower for 2026. The dollar's decline — driven by Treasury buyback operations and a weakening US fiscal outlook — has provided the euro with tailwinds independent of ECB policy. The US composite PMI at 56 versus the eurozone's 52.1 highlights the growth gap that still favors the dollar on fundamentals.

Schnabel said markets "seem to understand our reaction function very well," suggesting the Council's communication has been effective in managing expectations. She did not specify how far rates might ultimately rise.

The Governing Council will receive one more inflation reading before it meets: Eurostat's flash estimate for August, due September 1. If energy prices continue their climb, the case for a September hike strengthens. If inflation surprises to the downside, the Council could hold — but Schnabel's comments make clear the burden of proof has shifted to the doves.

This article is for informational purposes only and does not constitute investment advice.