Why we raised rates again and what lies ahead

Yesterday the ECB Governing Council raised interest rates by 25-basis points (0.25 per cent), to 2.5 per cent (the Deposit Facility Rate). 

In this blog I explain why I supported this decision, highlighting the evidence that led me there.

In my July blog, I set out three things I would be watching before September: whether the energy price rebound proved sustained, the path of core inflation, and the extent to which the June rate increase was feeding through to economic activity. The data that arrived over the summer answered some of those questions.

Eurostat’s flash estimate for August put euro area headline inflation at 3.3 per cent, up from 2.9 per cent in July. The rebound in energy prices I flagged in my July blog is showing up in the data. Clearly, energy prices have not faded and, if anything, are proving stickier than previously thought.

Core inflation has been more stable, with a small decline in August to 2.4 per cent on the back of slightly weaker services inflation.

Wage renegotiation takes time – especially in a labour market like this one, where employment growth and churn has slowed – so I expect nominal wage adjustment to this inflation shock to show up with a significant lag. Wage growth of 3.3% in Q2 was broadly in line with expectations, and, near-term, wage trackers point to stabilisation around this level. The delayed pass-through of the energy shock is likely to set a floor on wage growth this year and next.

The latest macroeconomic projections have average wage growth of 3.3 per cent in both 2026 and 2027. This baseline scenario, suggests second-round effects through wages are expected to remain contained. The projections include adverse and severe scenarios which, as well as higher energy prices, assume stronger second-round effects with higher inflation as a result. A milder scenario also allows for a more rapid normalisation of energy prices compared to the baseline.