Financial services giant MUFG suggests a tight decision is in the offing for the European Central Bank (ECB) concerning whether to raise interest rates this September. The upcoming Eurozone CPI report could be pivotal in this decision-making process. Despite the pressures from high inflation, MUFG maintains its base-case for the ECB to pause the rate hike and anticipates further short-term weakness for the Euro.

Key Points:

• Inflation Dilemma: The Eurozone CPI report for August, set to be released on Thursday, is projected to reveal a dip in headline inflation to 5.1% while keeping core inflation fairly steady at 5.3%. Core inflation so far this year has averaged 5.5%, peaking at a cyclical high of 5.7% in March.

• Balancing Act for ECB: MUFG argues that the high core inflation figures may warrant another 25 basis point rate hike by the ECB, raising the deposit rate to 4.00%. However, indicators of economic softness in Q3 and cautionary tones from the ECB may tip the scales towards a more conservative policy approach.

• Near-Term Outlook: Despite the uncertainty, MUFG remains of the opinion that the ECB will pause the rate hikes in September. The bank also suggests that risks for the Euro are skewed to the downside in the very near term.

• Market Sensitivity: Given the high stakes involved, the release of the Eurozone CPI report could result in significant market volatility, particularly for the EUR/USD currency pair and interest rates.

Conclusion:

MUFG believes that while the high inflation figures pose a compelling argument for another rate hike, factors such as Q3 economic performance and cautious language from the ECB make the decision a close call. The bank maintains its base-case expectation that the ECB will opt for a pause in rate hikes in September, along with a near-term weakening of the Euro. The upcoming CPI report could be a game-changer, setting the tone for the Eurozone's monetary policy and the trajectory of the Euro.