The European Central Bank Could Be About to Go Big on Its First Rate Hike in 11 Years

• A new anti-fragmentation tool and a sizeable rate hike would both come as the ECB deals with its primary mandate: price stability.
• The euro zone inflation print for June came in at 8.6%, up from 8.1% in May, and German producer prices in June were 32.7% higher than a year earlier.
• However, there are signs that things could be slowly improving.

FRANKFURT, Germany — The European Central Bank's Governing Council on Thursday is expected to have deep and candid conversations about the size of its first rate hike in 11 years, with the cost of living remaining stubbornly high in the region.

The euro climbed to almost a two-week high and euro zone government bond yields jumped on Tuesday morning after Reuters reported, citing a source, that the ECB will weigh up whether to opt for a 50 basis point hike as opposed to the 25 basis points already penciled in.

"It is possible that the ECB wants the option of a 50bp hike because of something its has seen in the unpublished inflation expectations data," said Mark Wall and his team at Deutsche Bank Research in a recent note.

"It is possible also that the option of a 50bp hike helps in negotiating the details of a strong anti-fragmentation tool," he added, mentioning the new stimulus plan that is due to be launched Thursday that would target surging debt yields in peripheral nations such as Italy.

Details of this new anti-fragmentation tool will be closely watched and come at a critical moment as Italy faces another severe political crisis.

"While ECB President Lagarde is likely to stress the temporary nature of the instrument, owing to the exceptional circumstances the euro area finds itself in, she will also underline the ECB's determination to secure the integrity of the monetary union, thereby trying to evoke a 'whatever it takes' spirit," said Dirk Schumacher of Natixis in a research note.

"The fine line President Lagarde will have to walk here — also in light of the political situation in Italy — increases the risk of a 'misunderstanding' and erratic market moves," Schumacher added.

The new tool and a sizeable rate hike would both come as the ECB deals with its primary mandate: price stability. The euro zone inflation print for June came in at 8.6%, up from 8.1% in May, and German producer prices in June were 32.7% higher than a year earlier. However, there are signs that things could be slowly improving.

"Prices of intermediate goods (excluding energy) did not rise as strongly as before. Here, the year-on-year comparison fell for the second month in a row, due among other things to somewhat lower prices of metals," Commerzbank analysts noted when looking at the recent data.

"As intermediate goods are ahead of consumer goods prices in this cycle, this gives rise to hopes that the latter will also peak in the coming months."

The economic outlook is very uncertain at this stage amid a rising risk of gas disruption during the next weeks. Europe is bracing for an extended shutdown of Russian gas supplies as maintenance continues on the Nord Stream 1 pipeline that brings gas to Germany via the Baltic Sea.

Some fear the suspension of deliveries could be extended beyond the 10-day timeline, derailing the region's winter supply preparations.

"Importantly, the ECB may have to keep tightening policy, even through a light recession, if wage acceleration and continued high energy prices result in rising inflation expectations," said Anatoli Annenkov in a research note.

"We believe raising the policy rate at least to the bottom of the range of estimates of the natural rate (1-2%) thus makes sense in order to be in a better position next year to address the inflation outlook," he added.

—CNBC's Sam Meredith and Elliot Smith contributed to this article.