On Thursday (September 3) during the Asian session, the euro traded in a narrow range against the US dollar, hovering around 1.1585, still near its lowest level since August 20. A 25 basis point rate hike by the European Central Bank next week is virtually certain, but the focus remains on whether this will be the last one this year.

A September rate hike is a foregone conclusion; this "insurance-style rate hike" strengthens credibility.

It is widely believed in the market that the European Central Bank will raise its official deposit rate by 25 basis points next week. The Eurozone economy has recently demonstrated unexpected resilience: on the one hand, some Asian competitors have been more severely impacted by the Strait of Hormuz blockade, leading to a partial shift of orders and supply chains to Europe; on the other hand, continued fiscal stimulus policies in many countries have jointly supported growth momentum. Overall inflation continues to rise, and the market generally expects it to remain above 3% this year, making it difficult for most policymakers to publicly oppose another rate hike. This rate hike is widely seen as an "insurance hike"—its core purpose is to further strengthen the central bank's credibility in combating inflation and effectively prevent energy price shocks from translating into indirect or second-round effects through wage negotiations and pricing behavior. The upcoming new employee forecasts are expected to slightly raise growth and inflation expectations, mainly due to upward revisions to first-quarter data and slightly higher-than-previously assumed oil prices. These adjustments will provide additional arguments for the rate hike camp, further solidifying the legitimacy of the September action.

After September: Further interest rate hikes remain uncertain.

Following the September rate hike, uncertainty remains regarding whether the European Central Bank (ECB) will continue to tighten policy. While the deposit rate has risen to 2.50%, it remains largely within the neutral range; further increases would imply that policymakers have clearly determined the necessity of restrictive monetary policy. However, there is a fundamental difference between the current economic resilience and a truly overheated economy. With public finances under pressure in many countries and soaring sovereign bond yields, the ECB is unlikely to risk deliberately creating a recession to address the supply-side shock of energy prices. The market has begun pricing in the possibility of at least one more rate hike before the end of the year, but policy divergences within the ECB have clearly intensified. Statements from hawkish officials such as Schnabel and Makhlouf suggest a continued willingness to raise rates, but others emphasize that energy-driven inflation should be treated differently from demand-pull inflation, and that policy should not overreact. The future path will heavily depend on subsequent data and the evolution of inflation expectations.

The Challenge of Soaring Bond Yields: The ECB Needs to Avoid Adding Fuel to the Fire

The recent surge in Eurozone bond yields has objectively completed some of the ECB's monetary tightening work—financing conditions have tightened significantly. Experience shows that a 50 basis point increase in bond yields has a slightly greater impact on inflation and growth than an equivalent increase in policy rates. However, the real challenge lies in the ECB avoiding further exacerbating the situation. While inflation is not yet fully under control, the central bank is more concerned with widening interest rate differentials between member states than with the absolute level of yields. If concerns about sovereign debt sustainability intensify, the Transmission Protection Instrument (TPI) may re-emerge in policy discussions. Especially with the French presidential election approaching, concerns about debt sustainability may escalate further, and the market may actively test the ECB's policy floor and willingness to intervene. How to maintain its credibility in combating inflation while preventing the risk of financial fragmentation from spiraling out of control will be the core test for decision-making in the next stage.

Summarize

The European Central Bank (ECB) is set to raise interest rates by 25 basis points next week, a move considered an "insurance hike." The path after September remains uncertain—a deposit rate of 2.50% would still be within the neutral range, highlighting the fundamental difference between economic resilience and overheating. Soaring bond yields are tightening financing conditions, and the ECB needs to avoid "adding fuel to the fire." The euro is likely to fluctuate between 1.1550 and 1.1650 in the short term. If the ECB hints at a further rate hike in December, the euro may find support; if it's confirmed that September will be the last hike, the euro may come under pressure. (Euro/USD daily chart, source: FX678) At 8:12 Beijing time, the euro was trading at 1.1585/86 against the US dollar.