SerpApi.Org
By Balazs Koranyi and Francesco Canepa
FRANKFURT, July 23 (Reuters) - The European Central Bank kept interest rates unchanged as expected on Thursday but held the door open to another increase in September, as a fresh jump in energy prices threatens to keep inflation well above its 2% target.
The ECB raised rates in June and hinted at more to come but a string of benign data on prices, wages, economic activity and inflation expectations in the weeks since has made a quick follow-up step less urgent.
A return of oil prices to almost $100 per barrel on the resumption of fighting between the United States and Iran is keeping pressure on the ECB, however, and financial investors and market economists expect a move at the bank's next meeting to stop the energy shock setting off a broader price spiral.
Natural gas prices, which had stayed relatively lower in recent months, are now also at their highest level in more than three years, adding to price pressures.
"Uncertainty remains high and the full inflationary impact of the energy shock has yet to play out," the ECB said in a statement. "The Governing Council is therefore closely monitoring the intensity and duration of the shock, as well as its indirect and second-round effects."
"The outlook for energy prices, while highly volatile, currently stands close to the baseline of the June Eurosystem staff projections and well above the levels recorded prior to the conflict in the Middle East," the bank added.
Investors are betting on almost three more interest rate increases in the coming year, with a first move fully priced in by October and the second by next February.
This pricing reflects energy prices more than economic fundamentals, however, and most economists polled by Reuters say the 21-country euro zone will need far less policy tightening to keep a lid on inflation, which could hover around 3% in the coming months, above the 2% target.
Given this mixed outlook, ECB President Christine Lagarde is likely to attempt a balancing act in her post-decision press conference.
She will want to signal that policymakers remain concerned about price pressures and further monetary policy tightening remains on the cards. But she needs to avoid stoking market expectations, as substantial action is already priced in.
NO SECOND-ROUND EFFECTS YET
The key reason the ECB can afford to be patient is that long-feared second-round effects of the energy price spike have yet to materialise.
High energy costs tend to raise the price of all goods and services and eventually force workers into demanding higher wages, setting off an inflationary wage-price spiral.
But wage growth is continuing to ease, the labour market is relatively soft — particularly in Germany, the bloc's biggest economy — and firms surveyed by the ECB are anticipating even more muted pay pressures.
Consumers have dialled back their price expectations, while detailed figures are showing next to no evidence of second-round effects. Services inflation actually slowed last month.
Moreover, continuing trade tensions, high energy costs and China's expansion into some of Europe's key export markets suggest that the bloc's industries will continue to struggle for years to come, putting downward pressure on labour demand.
Policymakers nevertheless argue that even if second-round effects are smaller and delayed, they are still coming and the ECB needs to be ready to act.
Scorching summer weather in much of Europe this month is also a potential risk. The heat may have damaged crops and could push up food prices, while low water levels on key rivers could create shipping bottlenecks.
(Reporting by Balazs Koranyi; Editing by Catherine Evans)
