Is inflation easing just an illusion? The European Central Bank is expected to stay put tonight, but there may be hawkish intentions behind the scenes.

After the European Central Bank raised interest rates by 25 basis points in June, tonight's (July) monetary policy meeting is almost a foregone conclusion - the ECB will press the "pause" button on rate hikes and keep deposit rates at the level of 2.25%. However, what really concerns the market is not this pause in action, but how much room the European Central Bank will open for further tightening of policy in September and beyond. As tensions in the Middle East escalate again and oil prices return above $90 per barrel, market expectations for further policy tightening are heating up. Rate pause but options retained Since the last rate hike last month and the suggestion of further action, a series of benign data in the eurozone - including lower-than-expected inflation, moderate wage increases, and falling price expectations - have significantly reduced the urgency for consecutive rate hikes. However, the conflict between the US and Iran is rapidly rewriting the economic script. Oliver Rakau, an economist at the Oxford Economics Research Institute, described this decision as a "hawkish pause", believing that current data slightly favor further tightening of policy, which is consistent with the ECB's forecast in June and market pricing. Currently, financial markets are pricing ahead. Traders expect the ECB to complete the remaining rate hikes by February next year at the latest, with a 60% chance of another rate hike in the middle of next year. According to Jens Eisenschmidt, an economist at Morgan Stanley, a deposit rate of 2.5% would already constitute a "moderate restrictive level", and once inflation approaches the target, there will be easy reasons to start cutting rates. Therefore, in his view, based on the benchmark forecast that inflation will just touch the target next year and then be slightly below the target, "there is no reason to raise rates more than twice". However, if Lagarde reiterates a "general consensus" on the policy direction at the press conference, or reminds the public that the forecast in June was based on the assumption of a total of three rate hikes, then the market's bet on a rate hike in September will be further confirmed. Second-round effects of inflation have not yet appeared, food risks may be brewing The biggest reason why the European Central Bank can afford to wait and see for now is that the long-feared "second-round effects" have not yet appeared. High energy costs usually transmit to various goods and services, then drive wage increases, forming a situation of price-wage spiral upward, but this has not been evident in the data. Eurozone inflation slowed to 2.8% in June, and service price pressures as well as core inflation excluding energy and food have also cooled. Wage growth continues to be moderate, the labor market overall is soft, especially in Germany, the largest economy in the eurozone; consumer expectations for future prices have also significantly declined. Nevertheless, a survey showed that about one tenth of economists have found evidence that inflation expectations are starting to become unanchored, and almost all respondents are concerned about second-round effects to some extent. ECB decision-makers also believe that even if the second-round effects are more delayed and smaller in scale, they will still come and the central bank needs to be prepared to act at any time. What is more complex is that the extreme heatwave sweeping across several European countries this summer, as well as the El Nio phenomenon, may have already damaged crops and pushed up future food prices, while low water levels in key waterways such as the Rhine may create bottlenecks in shipping. Barclays Bank warned in a report that despite a general decline in food inflation in recent months, unusually hot weather may once again create upward pressure on food prices. Risk balance disturbed by the situation in the Middle East: how will Lagarde walk the tightrope After a period following the June interest rate meeting when there was a ceasefire between the US and Iran, coupled with inflation data surprising to the downside, the market briefly thought the worst stage had passed. However, with the resumption of hostilities and oil prices stabilizing above $90 per barrel, expectations of tightening have resurfaced. This not only forces the European Central Bank to answer the question of "how much hike is enough", but also to clarify its judgment on the balance of risks. Lagarde will inevitably be questioned on how the eurozone's economic performance compares to the baseline scenario set in June and more pessimistic scenarios. Although oil prices have recently risen, considering the futures curve, their levels are still close to a more moderate path that would lead to faster inflation decline; on the other hand, natural gas prices are closer to a less favorable scenario. Benefiting from a brief ceasefire earlier, Lagarde had described inflation risks as more balanced than when rates were hiked in June; now that the conflict has reignited, whether this statement will be adjusted again will be a key detail for the market to capture the policy direction. At the same time, the European Central Bank must also face long-term headwinds - continued trade tensions, high energy costs, and China's continued expansion in some European key export markets mean that the eurozone's industry will continue to be under pressure in the coming years, which will in turn restrain labor demand and exert downward pressure on wages and prices. More than monetary policy: Lagarde's personal future adds variables In addition to economic and rate paths, Lagarde's press conference will inevitably face questions about her personal future. This French-born head of the ECB has continuously sparked speculation - she may step down before the end of her term in October next year. Lagarde herself recently admitted that she had considered leaving early when inflation approached the 2% target back in February, but she then stayed on due to the US attack on Iran. Recently, she announced plans to get involved in French political events in some capacity to increase the visibility of European issues, while stating that she will not personally seek public office. At the same time, rumors about her taking over as the permanent head of the World Economic Forum in Davos continue to circulate. The uncertainty in personnel adds an additional sensitive dimension to the European Central Bank's future policy communication.