On Thursday, July 23, the European Central Bank will hold its next meeting, after which the central bank is expected to leave all monetary policy parameters unchanged. This is the base case and the most anticipated scenario, which is already priced in. Therefore, traders' main focus will be on the accompanying statement and the press conference with Christine Lagarde.

At first glance, the latest macroeconomic data should suggest a dovish stance from the ECB. For example, June inflation in the Eurozone slowed to 2.8% year-on-year from 3.2% in May. Economic activity in the region also remains weak, with Eurozone GDP growth estimated at only 0.2%, and growth prospects continue to deteriorate. Just a few weeks ago, these factors allowed markets to consider a possible rate cut in the second half of the year.

However, the situation has significantly changed following a new round of escalation in the Middle East. The sharp rise in oil prices over the past month has again posed the ECB the problem of a potential second wave of inflationary pressure. For the European economy, which is highly dependent on energy imports, an increase in oil prices means not only a rise in overall inflation but also a risk of renewed increases in production costs, transport expenses, and service prices. For this reason, many members of the ECB's governing council have noticeably tightened their rhetoric in recent weeks.

Another "warning sign" for the central bank is the persistence of core inflation. Despite the slowdown in overall CPI, domestic price pressures remain quite strong due to wage growth and a relatively resilient labor market. For the ECB, these components are key and largely decisive, as they reflect long-term inflationary processes, rather than temporary fluctuations in energy prices.

Therefore, the July ECB meeting is unlikely to be characterized as "dovish." The most probable scenario is a "hawkish pause." This means the central bank will maintain all parameters of monetary policy unchanged while delivering a relatively tough rhetoric. Specifically, Lagarde will reiterate that the ECB remains "fully data-dependent, does not commit to any obligations, and is ready to act decisively in the event of a deterioration in the inflation outlook." Essentially, this is a standard set of phrases that Lagarde has used multiple times. However, in light of the rapid rise in oil prices, these standard phrases may take on new significance, as the risks of a new wave of inflationary pressure have noticeably increased.

At the same time, Lagarde is unlikely to signal a potential rate hike at the September meeting, aiming to maintain a balanced nature in her rhetoric.

Major investment banks also agree that the most likely outcome of the July meeting will be a "hawkish pause" scenario.

For instance, analysts at ING believe that the ECB will keep rates unchanged; however, Lagarde's speech will have a distinctly hawkish tone. In their view, a rate hike in September will become the baseline scenario if oil prices remain at current levels or continue to rise in the medium term.

Economists at Citigroup also do not expect any changes to rates in July but allow for one hike by the end of the year if high energy prices begin to translate into sustained growth in core inflation and wages.

A similar stance is echoed by analysts at Bank of America. The bank believes that the recovery of energy prices significantly increases the likelihood of a rate hike in September. However, in the longer term, BoA experts still expect inflation to return to the target of 2% and for monetary policy to gradually soften.

Overall, according to a Reuters survey, about 70% of economists expect one more rate hike from the ECB by the end of the year, with September being the most likely month cited. At the same time, nearly a third of experts polled believe that the acceleration of inflation in June could turn out to be temporary, meaning the ECB may indeed refrain from further tightening.

Thus, the formal outcomes of the July meeting are likely to be neutral, while the accompanying statement and Lagarde's rhetoric are likely to be noticeably firmer than expected a month ago. The latest macroeconomic data could certainly justify a softer tone; however, the renewed rise in oil prices and heightened inflation risks will prevent the ECB from even hinting at a soon softening of monetary policy.

The euro's reaction will depend on how "hawkish" Lagarde's rhetoric turns out to be. The market is likely to ignore standard vague formulations stating that further decisions will depend on incoming data. However, even a theoretical hint at the possibility of a rate hike in the foreseeable future would provide significant support for the euro and, accordingly, for EUR/USD buyers. In this case, the pair is likely to test the upper boundary of the established range of 1.1410 – 1.1470, which corresponds to the upper line of the Bollinger Bands indicator on the D1 timeframe.