European Central Bank Governing Council member and Bundesbank President Joachim Nagel has indicated that the ECB might need to raise interest rates to a level that curbs economic growth if energy prices remain persistently high. Speaking on Tuesday, Nagel said, "If we are faced with high energy prices like the current ones over a long period, I cannot rule out that we would have to enter a mildly restrictive monetary policy territory." He added, however, that it is still too early to make that determination.

A point of divergence exists within the ECB regarding the neutral rate level. ECB Chief Economist Philip Lane suggested earlier this year that the neutral rate could be as high as 2.5%—which is exactly the current policy rate. In contrast, Irish central bank chief Gabriel Makhlouf believes that rates would only enter restrictive territory once they exceed 2.75%.

Nagel also voiced concerns about potential second-round effects on inflation. "What I, or rather we, are concerned about is that this could produce second-round inflation effects," he said, pointing to upcoming wage negotiations in several countries, including Germany. "We all know that if this situation persists for a longer and longer time, we will see some second-round effects." This is why, he explained, "we must remain vigilant, and that is what we are saying in this context. And I can assure you that we are vigilant."

When questioned about the possible activation of the ECB's Transmission Protection Instrument (TPI) amid current bond market pressures, Nagel stated that the tool would only be triggered if there were a malfunction in the transmission of monetary policy. He stressed, "It has absolutely nothing to do with fiscal challenges facing one or another country in the euro area." This comment comes after France's 10-year government bond yield premium over German bunds surpassed 100 basis points last week for the first time in 14 years.

ECB Rate Hike Expectations Rise as Inflation Remains Key Concern

The ECB raised its deposit facility rate by 25 basis points to 2.50% on September 10, in line with market expectations, marking the second hike this year. In its policy statement, the Governing Council emphasized that ongoing Middle East conflicts are fueling inflationary pressures, with euro area inflation expected to remain significantly above the 2% target for an "extended period." ECB President Christine Lagarde clarified at the press conference that "extended period" implies "at least through the first half of 2027," with headline inflation projected to return to around the target level by late 2027.

Meanwhile, the ECB's latest projections show average headline inflation of 3.0% for 2026, unchanged from the June forecast; 2.5% for 2027; and 2.1% for 2028, with the latter two years revised upward from previous estimates. Core inflation, which excludes energy and food, is also expected to remain elevated, with three-year projections of 2.5%, 2.6%, and 2.3% respectively—all above the 2% policy target. Analysts suggest that the upward revision to inflation forecasts, combined with a data-dependent policy stance, provides grounds for further tightening. Markets anticipate up to three more rate hikes in the current cycle.

Adding to the case for tightening, the ECB's monthly survey released last Friday showed that euro area households' inflation expectations rose across the board in August—reinforcing the growing bets on further hikes following the second rate increase on September 10. The data revealed that the median one-year inflation expectation rose from 2.9% in July to 3.0%, the median three-year expectation increased from 2.7% to 2.9%, and the median five-year expectation climbed from 2.4% to 2.5%. The three-year median expectation is considered more relevant for monetary policy formulation. All three horizons remain above the ECB's 2% target, indicating that even households do not genuinely believe inflation will return to target within a visible timeframe.

Inflation expectations are not merely decorative in the ECB's policy reaction function. In its post-September decision statement, the central bank explicitly noted that policymakers are closely examining expectations because they shape future wage negotiations and corporate pricing behavior. The three-year metric is particularly scrutinized because it more closely aligns with the duration of wage contract cycles.

Lane warned this week that the renewed surge in energy prices means euro area inflation will stay elevated for longer than the ECB initially anticipated. "We are witnessing a second wave of price increases, not only in oil but also in gas," he said. "We believe this energy price rise will make inflation higher and more persistent, before it declines toward our target from mid-2027 onwards."

ECB Governing Council member and Slovak central bank chief Peter Kazimir stated that the ECB would not hesitate to raise rates further if necessary, but determining the next move will take time. He noted that officials first need to assess whether the indirect effects of the war-driven surge in energy costs are developing as expected, and whether "demand and labor market conditions are strong enough to produce second-round effects."

ECB President Lagarde's stance appears more cautious. Last Friday, she remarked that a jump in energy prices does not automatically translate into monetary tightening. "Rates do not move in tandem with energy prices," she said. "Because obviously, energy prices and their impact on prices also feed into other factors, especially growth and consumption. We take all those elements into account; a synchronized linkage mechanism is not one that operates in practice."