Why the ECB's December cut became a September hike

The European Central Bank is expected to raise its deposit rate by a quarter of a point on September 10th, the second increase this year and one that markets already treat as done. Most economists expect the bank to lift the deposit rate to 2.5 per cent at that meeting, and roughly 80 per cent of economists polled by Reuters expect it to end the year there and to stay until 2027. The question that circulated a year ago — would the ECB cut in December? — has been settled early, and in the opposite direction. This December's meeting will decide, at most, whether to hold still or go up again.

For an American investor this is not a Frankfurt curiosity. It is the reversal of the trade that made European stocks popular a year ago: the belief that tame inflation would let the ECB keep rates low and cheap European equities re-rate. Two pieces of background explain how that got undone, and why the December meeting still matters even though a cut has left the table.

First, the starting point. The ECB had pushed its deposit rate to 4 per cent by September 2023, then cut eight times to 2 per cent; at the end of 2025, with the deposit rate at 2 per cent and inflation close to target, it had gone four meetings without moving, and markets were asking when the cuts would resume. Up to the eve of 2026, the question was when, not whether, the next cut would arrive.

Then the world intervened. The breakdown of the American understanding with Iran and the war that followed menaced the Strait of Hormuz, the chokepoint for about a third of the world's seaborne crude. The World Bank now expects energy prices to be 24 per cent dearer this year than last, the biggest surge since Russia's invasion of 2022, with Brent averaging $86 a barrel against $69 in 2025 — and, in a scenario of further escalation, $115. A euro area that imports much of its energy, priced in dollars, cannot dodge the bill.

Now the paradox at the centre of the September decision. Eurostat's flash estimate put headline inflation at 3.3 per cent in August, up from 2.9 per cent in July. The reading was the highest since September 2023, powered by a 14.3 per cent jump in energy prices. Yet the measures of home-grown pressure moved the other way: core inflation, which strips out food and energy, eased to 2.4 per cent from 2.5 per cent, and services inflation cooled to 3 per cent. That is the signature of an imported shock — dearer things bought from abroad, not a boom at home. The ECB has said as much, projecting in its July accounts that headline inflation would remain well above target into the first half of 2027, even as some of its own members argued, as early as July, for another rise.

So why tighten into a shock the bank cannot reverse? Higher rates do not reopen a strait. The purpose is defensive, and threefold. The first aim is to keep the energy spike from feeding into wages and prices as it did in 2022, when a temporary shock became a durable one. The second is to preserve the credibility to cut again once the shock fades. The third is to support the currency — because a weak euro makes dollar-priced energy more costly still. At a deposit rate of 2.5 per cent, still 150 basis points below the peak of 2023, a quarter point is cheap insurance against the costliest of the ECB's habits: waiting too long and then over-correcting.

The currency is also the second-order effect the December consensus missed, and the one that touches an American most directly. The euro trades below $1.16, weaker than when the year began, with war-driven demand for dollars and a Federal Reserve under its new chairman, Kevin Warsh, that has opened the door to more of its own hikes outweighing a hawkish ECB. In January a strong euro was expected to drag prices down; by summer a weak one is pulling them up, since it raises the local cost of imported energy. For anyone holding unhedged European funds the effect compounds: euro-denominated gains are converted back into dollars at a less generous rate. The mood shows up in allocations: Vanguard's FTSE Europe fund, a $31bn vehicle, has absorbed roughly $1bn of net redemptions this year.

None of this makes 2022-23 the right comparison. Oil markets entered the conflict with a supply surplus and fuller inventories, and the IEA's coordinated release of 400 million barrels dwarfed the 182 million released after Russia's invasion; the ECB itself has made this point, partly to restrain the panic the headline numbers invite. The Reuters poll's summary of September — the final rate rise in the shortest tightening drive since 2011 — captures the council's aim: a brief, defensive push, not a campaign.

That bears directly on December. The most likely outcome is another hold, with a minority of economists still expecting a further rise before the year is out. But a framework of "cut or hold" is the wrong lens. What the council does in December will be set by gas prices this winter, the course of the war and the path of the dollar — variables no Frankfurt rate can steer. This is the honest meaning of the ECB's meeting-by-meeting approach: it has traded the comfort of promised direction for the freedom to reverse itself, which it has now done within the space of a year.

The December cut that markets once thought they saw was never more than a projection pinned to a fading disinflation. That it dissolved so quickly is the lesson; the euro is the tell. If the currency firms on the back of these hikes, the defensive strategy is working, imported inflation fades, and the road to the 2027 cuts opens. If the euro slides regardless, Frankfurt will find its "final" hike is not final and its December hold a promise it cannot keep. The behaviour to watch is not in Frankfurt at all. It is on foreign-exchange screens, where the limits of the 2 per cent mandate meet the world that moves it.