The longer the war continues, the more likely rate hikes will become, central bank warns
FRANKFURT — The European Central Bank on Thursday decided to keep its key interest rate at 2 percent, opting for patience as it gauges the economic fallout from the U.S.-Israeli war on Iran.
Chief Economist Philip Lane had already signaled the wait-and-see stance last week, warning that it was still too early to judge whether Europe is facing a temporary shock or something more persistent that would require action from the central bank.
The ECB kept the option of a rate hike at its next meeting in June firmly on the table after inflation accelerated to 3 percent in April, having hovered around the Bank’s 2 percent target for nearly a year before the war started.
“The Governing Council is not pre-committing to a particular rate path,” the ECB said in a statement that observed that “upside risks to inflation and the downside risks to growth have intensified.”
The Bank said that implications of the war for medium-term inflation and economic activity will depend on the intensity and duration of the energy price shock and the scale of its indirect and second-round effects. “The longer the war continues and the longer energy prices remain high, the stronger is the likely impact on broader inflation and the economy,” it said.
The ECB observed that longer-term inflation expectations remain well anchored, although they have moved up significantly as regards the near term.
Financial markets have focused more on those rising short-term inflation expectations. They are increasingly convinced the ECB will act to rein in inflation before long. In addition to a hike in June, when updated growth and inflation forecasts should offer clearer information about price trends, they now reflect expectations of two more rate hikes before year-end. This is one more than was expected only a week ago.
Not everyone is convinced. Economists warn that a deteriorating growth outlook, following a meager 0.1 percent expansion in the first quarter, complicates the case for tightening and risks tipping the region into recession.
All eyes now turn to ECB President Christine Lagarde, whose press conference will be scoured for signals on whether she endorses the current market pricing — or pushes back due to the implications for economic growth.