ECB Governing Council Member Nagel: If energy prices remain high, interest rates may need to be raised to a moderately restrictive level

According to Zhitong Finance APP, European Central Bank Governing Council member and President of the Bundesbank Joachim Nagel stated that if energy prices remain high, the ECB may have to raise interest rates to levels that restrain economic growth. On Tuesday, Nagel said: "If we are faced with high energy prices like now for an extended period, I cannot rule out the possibility that we will have to enter a moderately restrictive range for monetary policy." However, he also added that it's still too early to make this determination.

It’s worth noting that there are different views within the ECB regarding the neutral interest rate level. Earlier this year, the ECB's Chief Economist Philip Lane stated that the neutral rate could be as high as 2.5%—which is exactly the current ECB rate. However, Central Bank of Ireland Governor Gabriel Makhlouf believes that only when rates exceed 2.75% does it enter a restrictive range.

Nagel also said: “What I—or rather, we—are concerned about is that this may lead to second-round inflation effects.” He was referring to upcoming wage negotiations in some countries, including Germany. "We all know that if this situation lasts longer and longer, we will see some second-round effects." He stated this is why "we must stay vigilant," and added, “That’s what we are saying in this context. And I can assure you, we remain vigilant.”

Given the current pressure on the bond market, when asked whether the ECB’s so-called Transmission Protection Instrument (TPI) could be activated, Nagel indicated that this tool would only be deployed in case of problems with the monetary policy transmission mechanism. He said: “It has nothing to do with the fiscal challenges faced by one or another country in the euro system.” Last week, the yield spread between 10-year French government bonds and German bunds exceeded 100 basis points for the first time in 14 years.

Expectations of ECB Rate Hikes Intensify as Inflation Remains a “Persistent Thorn”

On September 10th, the ECB raised rates by 25 basis points, lifting the deposit facility rate to 2.50%, in line with market expectations. This marked the ECB's second rate hike this year. In its policy statement, the ECB’s Governing Council emphasized that continued Middle East tensions are adding inflationary pressure, with eurozone inflation expected to remain significantly above the 2% target level “for an extended period.” During a press release, Lagarde clarified that “for an extended period” means “at least until the first half of 2027,” with overall inflation anticipated to return close to target around the end of 2027.

Meanwhile, the ECB’s latest forecasts show the average headline inflation expectation for 2026 is 3.0%, unchanged from the June projection; 2.5% for 2027 and 2.1% for 2028, with both the latter figures revised upwards. Core inflation excluding energy and food also remains high, with three-year forecasts at 2.5%, 2.6%, and 2.3%, all above the 2% policy target. Some analysts believe that an upward revision in inflation forecasts, combined with data-dependent policy stances, provides grounds for the ECB to further tighten. The market anticipates that there could be up to three more rate hikes in this cycle.

Additionally, a monthly survey released by the ECB last Friday showed that eurozone households’ inflation expectations rose across the board in August—adding further support to tightening bets that have intensified after the second rate hike on September 10th.

Data indicates that the median one-year inflation expectation rose to 3.0% in August from 2.9% in July, the three-year expectation rose to 2.9% from 2.7%, and the five-year median increased to 2.5% from 2.4%. The three-year median is of particular reference value for monetary policy making. All three terms remain above the ECB’s 2% target, which means that even based solely on households' views, “inflation returning to target” is far from being fully trusted within the foreseeable timeframe.

In the ECB’s policy reaction function, inflation expectations are not merely decorative. The ECB made it clear after the September decision that policymakers are scrutinizing expectations—because expectations shape future wage negotiations and corporate pricing behaviors. The three-year indicator is especially closely watched, as it best aligns with the duration of wage contract pricing cycles.

Lane warned this week that a new round of high energy prices means inflation will stay elevated in the eurozone longer than initially expected by the ECB. He said: “We are seeing a second wave of price increases, not just in oil but also in natural gas. We think this wave of energy price hikes will make inflation higher and more persistent, before falling back toward our target from mid-2027 onward.”

ECB Governing Council member and Slovak central bank governor Peter Kazimir said the ECB would not hesitate to raise rates further if necessary, but that deciding on the next step would take time. He stressed that ECB officials must first assess whether the indirect effects of war-driven energy cost surges are developing as expected, and “whether demand and labor market conditions are strong enough to create second-round effects.”

ECB President Lagarde’s tone was more cautious. Last Friday, she stated that soaring energy prices do not automatically translate to monetary tightening. She pointed out: “Interest rates will not fluctuate in sync with energy prices. Because, clearly, energy prices and their impact on goods prices will also influence other factors, especially growth and consumption. We will take all these elements into account—the linkage mechanism is not one that is practically applicable.”