ECB Hikes Rate To 2.50%, War Driven Inflation Takes Priority

In a much-anticipated move, the ECB decided to raise rates by 25 bps, taking the deposit facility rate at 2.50%, main re-financing rate to 2.65%, and the marginal lending facility rate to 2.90%. This marks the second - rate hike of the year, following a 25-bps increase in June. Renewed tensions in the Middle East, have kept oil prices elevated, with ECB highlighting this as the major source of inflationary pressure in the Eurozone. Christine Lagarde has highlighted that inflation is set to remain well above target for an "extended period". ECB remains focused on curbing inflationary pressures despite moderate growth outlook with GDP growth projected at only 0.9% for 2026.

Modest Recovery In Growth For 2026, Growth Outlook Shows Improvement

The ECB expressed confidence in the resilience of economic activity despite the headwinds coming from the global energy shock. Improving consumer confidence has helped lift demand in services, while higher government spending on defense and infrastructure has strengthened manufacturing activity. Al-related activity is also gaining momentum across digital services, business investment and exports.

The labor market remains relatively strong, with unemployment unchanged at 6.4% in July. Demand and supply of labour continue to slow simultaneously, while improving productivity could support economic activity.

Improving private consumption and public spending have led the ECB to revise its growth forecasts upwards to 0.9% for 2026, 1.4% for 2027 and 1.5% for 2028.

Inflation Has Risen Sharply, Energy Shock Keeps Upside Risks Elevated

Inflation in the Eurozone increased to 3.3% in August from 2.9% in July, driven largely by energy inflation, which rose to 14.3% from 10.3%. Inflation excluding energy and food (core) however, eased to 2.4% from 2.5%. While as of now. the inflation pressure seem to be concentrated, it could gradually feed into other segments of the CPI basket, while expected resilient growth could further add to inflation. Headline inflation is expected to remain well above the ECB's 2% target into H1 2027, with the ECB projecting inflation at 3.0% in 2026, 2.5% in 2027 and 2.1% in 2028.

Risks remain tilted to the upside as the Middle East and Russia-Ukraine conflicts leave energy markets vulnerable to further disruptions. A colder winter and low storage levels could push gas prices higher, increasing the risk of second-round effects and inflation staying higher for longer.

Markets Remain Under Pressure

European equities remained under pressure, with the STOXX 50 (-0.7%), CAC 40 (-0.5%), and DAX (-0.8%) closing lower. Meanwhile, the German 10Y Bund yield rose to 3.50%, while Brent crude remained elevated at USD 108/bbl, reflecting persistent geopolitical and energy market concerns.

lonic Wealth View

With ECB delivering another 25-bps hike in September, the key question now is how much further rates could rise? ECB's intent is quite clear - they are focusing on inflation despite economic growth staying below 1%. We believe the ECB is unlikely to hesitate in raising rates further if inflationary pressures intensify, with markets currently pricing in another hike in December. Within DMs, ECB and BoJ are tightening policy while the Fed also seems determined to bring inflation back towards 2%, suggesting that inflation is taking precedence over near-term growth for most of the key economies globally. With inflation and interest rates expected to be higher for some time, a more diversified approach across asset classes and geographies is favourable. Assets and geographies which are better insulated during times of higher inflation environment could be considered including real assets, quality equities and select emerging markets.

(Source: ECB, Ionic Wealth)