European Central Bank may hike rates amid inflation-recession dilemma

The European Central Bank (ECB) is expected to opt for limited rate increases, pursuing a cautious tightening path as it confronts persistent inflation pressures and a weakening growth outlook without triggering a massive tightening cycle amid an inflation-recession dilemma in the bloc.

Rising oil prices linked to tensions in the Middle East continue to fuel inflationary pressures globally, narrowing the policy options available to central banks.

Higher energy costs also continue to pose risks to European economies, which remain heavily reliant on energy imports.

Against this backdrop, the ECB faces a more challenging policy environment as inflation risks continue to rise.

Financial markets expect the ECB to raise all three key interest rates by 25 basis points on Thursday, while pricing in two additional rate increases before the end of the year.

Analysts say the ECB could find itself balancing inflation risks against a weakening economic outlook as policymakers navigate competing pressures.

Jan-Paul van de Kerke, senior economist for the Netherlands and the eurozone at ABN AMRO, told Anadolu that the ECB has shifted toward a tighter policy stance, with ECB President Christine Lagarde signaling that the time has come for policy adjustments.

"We expect rate rises at the June and July meetings, taking the deposit rate to 2.50%," he said, noting that the tightening trend is supported by the recent rise in long-term inflation estimates.

He said second-round inflation effects are likely to remain limited and that the ECB will have sufficient confidence in the outlook to gradually return rates to a neutral level by 2027.

"We expect one rate cut each in Q1 and Q2 2027, bringing the deposit rate back to 2%," he added.

Marco Wagner, senior economist at Commerzbank, told Anadolu that the ECB is expected to raise its key rates at this week's meeting, while another 25-basis-point increase remains likely by September due to inflation risks.

"However, we consider a third hike around the turn of the year—as is currently priced in by the markets—to be unlikely," he said.

Elwin de Groot, head of ECB and eurozone macro strategy at Rabobank, told Anadolu that the ECB is likely to revise its inflation projections upward, while growth could prove weaker than forecast in March.

De Groot said the ECB is expected to implement several rate increases as a risk-management measure, but a broader tightening cycle remains unlikely, adding that economic growth is expected to be significantly weaker and that a stronger stagflationary shock linked to developments surrounding the Strait of Hormuz could emerge.

"Our inflation forecasts are now close to, or even a bit above, the ECB's adverse scenario," he added.

Alain Durre, head of Europe macro research at Natixis, told Anadolu that the ECB will raise rates by 25 basis points.

"We also expect President Lagarde to adopt a moderately dovish tone regarding the possible future interest rate path to avoid triggering the expectations of a prolonged hiking cycle, reinforcing the data-dependent and meeting-by-meeting ECB policy approach," he said.

Durre said the temporary nature of the energy shock and weak economic growth are likely to steer the ECB toward a cautious approach to further rate increases.

He added that the bank's precautionary rate increase is unlikely to lead to a prolonged tightening cycle given weak economic momentum.

"A second hike is possible between July (with a probability of 35%) and September (55%) conditional to the duration of the Hormuz strait blockade," he added.