- Economic recovery is now at risk
- Inflation risks have heightened due to the Middle East conflict
- Risk of a stragflationary trend cannot be ruled out even if economy, labour market remain resilient
- The duration of the Middle East conflict will be the decisive factor
- It was a justifiable decision to wait before raising interest rates in April meeting
- But that doesn’t mean one should wait too long before taking action
- That especially if the situation regarding energy prices does not improve rapidly and significantly
- If the war persists for an extended period, the risk of second-round effects will increase
- ECB will remain vigilant and, if necessary, act in a timely and decisive manner
- There are no major changes to medium and long-term inflation expectations yet, but there are initial signs
- It would be irresponsible to commit to any decision many weeks in advance (when asked about next meeting)
- But unless the situation improves significantly, a rate move will be unavoidable in the near future
They have to play things down a little after the April move but as the war rages on, they can’t afford to stay on the sidelines for too long. And markets are also making that clear, pricing in ~80% odds of a rate hike by the time we get to the next meeting in June. It would be poor form for the central bank to walk back on that and undo the tightening from markets, particularly at a rather sensitive time such as this one.
That being said, the ECB is put in a very tough spot to balancing policy and prevailing economic conditions. The hit from the US-Iran conflict on households is going to be a big one. And amid resurgent inflation pressures, there is genuine concern of a stagflation hit to the euro area.
