The ECB raised rates by 25 bps; U.S. August PPI slightly exceeded expectations; the market’s probability of a Fed rate hike in September has risen to 70%. How should we interpret this set of macroeconomic data?

If one interprets this set of data simply as 'the ECB raised rates, U.S. PPI ran hot, so the Fed may follow suit,' that only captures the surface. What truly warrants attention is that the dominant narrative markets have been pricing in for the past year—namely, inflation easing, central banks cutting rates, and interest rates declining—is now being disrupted once again. Half a year ago, markets were still debating how many times the Fed might cut rates over the course of the year; today, the discussion has shifted to whether the Fed will hike again in September. The ECB has already acted first; U.S. long-term Treasury yields are once again approaching 5%, the dollar is strengthening, and gold is under pressure. Though these appear to be separate news items, they all stem from the same underlying question: With energy prices rising anew, could global inflation face a second wave? The real shift isn’t that one central bank hiked by an extra 25 bps—it’s that markets are beginning to doubt whether the anti-inflation cycle, previously thought to be nearing its end, may in fact not yet be over. The ECB’s latest hike illustrates this most clearly. It raised its key policy rates by 25 basis points, lifting the deposit facility rate to 2.50%. The issue, however, is that the European economy isn’t strong enough to warrant a rate hike for ‘cooling down.’ Growth remains modest at best, and neither manufacturing nor household consumption shows signs of overheating. What’s truly forcing the ECB’s hand is renewed upward pressure on inflation expectations following the rebound in energy prices. This echoes conditions seen in 2022 and early 2023: oil, natural gas, and transportation costs rose first, squeezing corporate profits, which then passed through to goods and service prices—and ultimately triggered wage demands from workers. If this transmission chain runs its full course, an external energy shock could morph into persistent core inflation that proves difficult to tame for years. Thus, the ECB now faces a difficult choice. Raising interest rates won’t boost oil production or eliminate geopolitical risks; instead, it will raise corporate financing costs, mortgage rates, and government debt servicing burdens. Yet the ECB fears an even costlier outcome: if markets conclude the central bank tolerates inflation above 3%, households and firms may gradually accept permanently higher prices—making it far more expensive later to re-anchor inflation expectations. Put simply, this rate hike isn’t happening because the European economy is too strong—it’s happening because the ECB prefers to sacrifice some growth rather than risk letting inflation expectations become unmoored once again. The U.S. situation is even more complex. After the release of August’s PPI, markets’ initial reaction was, “Inflation is heating up again.” But rather than viewing the PPI as broadly exceeding expectations, what truly alarmed markets was its internal composition. Rising energy and commodity prices were unsurprising—but what mattered more was that transport services, healthcare, and airfares showed no meaningful cooling. These components feed directly into subsequent PCE inflation. That means the Fed may now be worried about something far more serious than just “higher gasoline prices.” A short-lived spike in crude oil prices would pose no urgent dilemma for the Fed, since monetary policy cannot resolve supply-side shocks. But if rising oil prices begin transmitting through transport costs, corporate pricing power, and service-sector prices—ultimately feeding into core PCE—that changes everything. An energy shock would then evolve from a one-off price surge into genuine second-round inflation. Meanwhile, the U.S. labor market hasn’t weakened enough to force the Fed toward a dovish pivot. If employment deteriorated significantly, the Fed would naturally prioritize recession risks. But with the economy still showing resilience and inflation showing signs of re-acceleration, the Fed retains both the justification and the room to maintain high rates—or even deliver one more hike.

Hawkish signals return! Markets now bet the ECB will hike three more times before mid-2025; reports indicate officials are considering hiking as early as October.

Following the ECB’s latest rate hike, market expectations for further monetary tightening have surged markedly. Interest rate swaps now fully price in three additional 25-basis-point hikes by the ECB before mid-2025—amounting to a cumulative tightening of roughly 76 bps by June 2025. Previously, markets had only fully priced in three hikes by October 2025. At the same time, Bloomberg, citing informed sources, reported that ECB officials have placed further rate hikes under active consideration—with a possible move as early as October. According to these sources, to rein in inflation persistently above 3%, the ECB may need to adopt a more restrictive monetary stance. However, the market’s current pricing of three additional hikes may be overly aggressive; December may prove a more appropriate timing for the next hike, as that is when the ECB will release its updated economic projections covering the period through 2029. Bond markets have likewise reacted swiftly to the tightening expectations. Germany’s 10-year sovereign yield surged 6 bps to 3.51%, hitting its highest level since 2009. Energy-driven inflation pressures fuel market bets on further ECB hikes On September 10, the ECB’s Governing Council announced a 25-basis-point increase across all three key policy rates, in line with market expectations. The decision takes effect on September 16, raising the deposit facility rate, main refinancing operations rate, and marginal lending facility rate to 2.50%, 2.65%, and 2.90%, respectively.

ECB's Lane Says New Energy Shock Will Lead to Longer Inflation

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ECB Chief Economist Philip Lane warns that surging oil and gas prices will drive persistent euro area inflation through mid-2027. The energy shock exerts upward pressure on food and general goods, prompting potential further interest rate tightening.

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