The European Central Bank kept its key interest rate at 2% today and warned that the war in Iran was clouding the outlook for growth and inflation in the euro zone.
Oil and gas prices have surged since U.S. and Israeli attacks on Iran began, raising concerns that higher energy costs could push up consumer prices and weigh on economic activity across the 21-nation currency bloc, which depends heavily on imported fuel.
“The war in the Middle East will have a material impact on near-term inflation through higher energy prices,” the ECB said. “Its medium-term implications will depend both on the intensity and duration of the conflict and on how energy prices affect consumer prices and the economy.”
The central bank left the door open for future action, saying it was closely monitoring developments in energy and commodity markets and how they influence wages, consumer behavior, and corporate pricing.
ECB President Christine Lagarde described the euro zone as resilient and well positioned to deal with the shock, but she did not repeat her recent description of the economy as being “in a good place.” She emphasized that policymakers were watching the ripple effects of the conflict on inflation and growth.
The ECB’s decision aligns with other major central banks, including the U.S., Canada, Japan, Britain, Sweden, and Switzerland, which delivered similar cautionary messages about rising energy costs.
Financial markets are now pricing in inflation in the euro zone climbing toward 4% over the next year, before gradually returning to the ECB’s 2% target. Traders expect two or three rate hikes by December, although most economists still predict no change this year. The concern is that another spike in energy-driven inflation could force the ECB into action, recalling the surge that followed Russia’s 2022 invasion of Ukraine.
Today’s decision leaves the policy rate roughly matching February inflation, before the February 28 attacks on Iran. ECB projections show inflation at 2.6% in 2026, 2% in 2027, and 2.1% in 2028, with growth at 0.9%, 1.3%, and 1.4%, respectively. An adverse scenario reflecting higher energy costs is expected to be released later today.
Economists note that persistent energy shocks could push headline and core inflation well above target, prompting the ECB to raise borrowing costs. Barclays analysts wrote that a sustained Brent crude price of around $100 a barrel and natural gas at 70 euros per megawatt-hour could trigger rate hikes later this year.
Policymakers are mindful of lessons from the 2022 energy crisis. HSBC economist Fabio Balboni said the ECB may act faster this time if energy pressures persist, given the lingering “scars” on households and businesses. Isabel Schnabel, a leading ECB policymaker, added that tighter monetary and fiscal policies now should help limit inflationary pressures compared with the earlier crisis.
The euro zone faces a delicate balancing act: managing inflation risks from the Iran war while sustaining growth in an energy-dependent economy.
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