EUROPEAN INFLATION: September Headline Tracking Update: Marginal Upside Risks

Yesterday’s late selloff in rates pushed ESTR 1y1y above 3% for the first time since October 2023. While 1y1y has drifted down 2bps to 3.006% this morning, it is still consistent with the ECB  raising the deposit rate into mildly restrictive territory in response to the Iran war energy price shock. Focus at next week’s ECB decision will be on the updated macroeconomic projections, and whether President Lagarde implicitly endorses market pricing by noting that the Governing Council’s reaction function is “very well understood”.

• Renewed tensions between the US and Iran have continue to push crude oil and natural gas prices higher. The generic 3rd TTF future (currently Z6) is now at E73MWh, the highest since 2023. The ECB’s average scenario in the June macroeconomic projections assumed an average price of E60MWh in Q3.
• This has increased concerns around second round inflation dynamics within the Governing Council, particularly with the economy providing resilient so far this year.
• In an interview with the FT this morning, Bank of Ireland Governor Makhlouf said that the ECB should move into restrictive territory (i.e. 2.75% and above) if there was a “a significant shift in an upward direction, in terms of inflation risks”. That said, he said that it’s not yet clear that such a move is needed, owing to anchored inflation expectations and contained wage inflation.
• Speaking to Le Monde, the hawkish Nagel refrained from giving guidance beyond September. He (alongside Makhlouf) supports a September hike, noting that “inflation is too high, and the likelihood of second-round effects increases when inflation remains high for an extended period.”

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The Islamic Revolutionary Guard Corps (IRGC) confirmed that four of its air force personnel were killed in the latest US strikes on the western Kermanshah province. Semi-official Mehr also reports that three members of the paramilitary Basij force were killed and others wounded in a US strike on Lavan Island. 

• This comes as the latest part of a series of tit-for-tat strikes that began over the weekend. The latest Iranian strikes targeted US military targets in Jordan, Iraqi Kurdistan, Bahrain and Kuwait.
• Iran claims to have killed "a number" of US service personnel at Ali Al Salem Air Base in Kuwait, but this has not been confirmed by the US.
• As has been the case with previous instances of escalation, observers will now wait to see whether the attacks continue to ratchet up, or if the fact that both countries have struck one another's assets suffices in making both sides feel they have made their point.
• For the US' part, in recent weeks it had appeared that Treasury Secretary Scott Bessent and his policy of 'economic D-Day' sanctions against Iran had become the focal point of policy, rather than Secretary of Defense/War Pete Hegseth's preference for kinetic strikes.
• These strikes from the US may have been a display to Iran that even with Washington's preference for sanctions, it can still hit targets across the country, rather than the start of a full-scale escalation (although in such a fast-moving environment the risk of a prolonged exchange of fire remains very possible).