ECB official: If Middle East conflicts push up inflation, the central bank may raise interest rates earlier!

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The energy price surge triggered by the Iran war is reshaping expectations for European Central Bank policy. Several ECB officials have warned that if higher energy prices flow through to broader consumer prices, the central bank will act decisively, with market bets on rate hikes heating up as a result.

On Tuesday, according to Bloomberg, ECB Governing Council member and Slovak central bank governor Peter Kazimir stated that the timing of a rate hike "may be closer than many expect" and that further rate cut discussions are "now completely off the table." Bloomberg data shows that the probability of an ECB rate hike before June is currently priced at 60%, with further hikes before year-end at about 35%.

On the same day, Bundesbank President Joachim Nagel stated that if rising energy prices translate into broad-based consumer price inflation, the ECB will "act swiftly and decisively." ECB President Christine Lagarde also emphasized that all necessary measures will be taken to ensure inflation is controlled, and will not allow a repeat of the inflation shock of 2022–2023.

Rate hike expectations rise, no change expected next week

Slovak central bank governor Peter Kazimir's statement is the strongest among recent ECB officials. He made it clear that the inflation risk balance has "obviously tilted upward" and stressed that a rate hike does not need to wait for the quarterly forecast report, stating "I have no reservations about raising rates without new forecasts."

The ECB is expected to keep rates unchanged at its meeting next week and present several scenarios for growth and inflation in the context of ongoing conflict. According to Reuters data, money markets currently price the probability of the policy rate reaching 2% by year-end at just above 50%.

Diverging views among officials

Although expectations for rate hikes are rising, there is still no unanimous hawkish stance within the ECB.

Bundesbank President Joachim Nagel expressed support for a "wait-and-see strategy," stressing that the current situation is still too volatile to reliably assess medium- and long-term impacts. French central bank governor Francois Villeroy de Galhau stated, "Given the current situation, I don’t think now is the time to raise rates."

ECB Vice President Luis de Guindos added that the war's impact on Europe depends on its duration and intensity: "We need to stay calm and not overreact." Executive Board member Piero Cipollone also commented, "It is still too early to assess the impact of the war."

Lessons from 2022 inflation heighten caution

ECB officials broadly compare the current situation to the energy inflation shock triggered by the Russia-Ukraine conflict in 2022. Back then, the ECB initially characterized inflation as a temporary phenomenon and responded slowly, eventually being forced to sharply raise rates.

Slovak central bank governor Kazimir warned that businesses remember the inflation year all too well and will "pass on costs to consumers even faster than in 2022," while workers will "demand wage increases more quickly than before." He believes that inflation expectations have already started to rise, an early signal that price shocks could have lasting effects.

According to Reuters data, after peaking in 2022, inflation in the euro area has hovered around 2% for over a year. Bundesbank President Nagel stated that the current turmoil "has likely ended the recent discussion on inflation running below target."

Growth concerns and fiscal risks coexist

ECB council member Kazimir said that despite the uncertainty, he remains "quite optimistic" about growth and "not too worried" about the risk of stagflation. But he also issued a clear warning to governments: expensive subsidy measures should not be used to shield consumers and businesses from high energy costs, especially since some member states already have fragile fiscal conditions.

"Undoubtedly, governments will propose various relief measures," he said. "I strongly recommend against this, and encourage governments to ensure any measures are highly targeted and very time-limited. But this has never happened in the past."

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