The ECB is expected to maintain its interest rates for the seventh consecutive time this week, against a backdrop of resurgent inflation linked to the war in Iran.
On Thursday, the ECB is therefore likely to maintain its hawkish rhetoric and let the market do the work for it. Indeed, rates (both short and long-term) have risen sharply since late February. Monetary tightening has thus already occurred, as financing costs are higher for corporations and sovereigns alike.
But this strategy has its limits. Faced with high inflation, the ECB will ultimately have to act. "The public might find it difficult to understand a reaction function that does not react," Christine Lagarde admitted in late March.
The conflict in the Middle East has triggered a surge in energy prices, which particularly affects Europe due to its heavy reliance on fossil fuel imports. In March, Eurozone inflation climbed to 2.6%, its highest level since July 2024.
Thus, while the ECB is expected to stand pat this month, a majority of economists surveyed by Reuters expect a rate hike in June. This is also what markets are anticipating. In total, two 25-basis-point rate hikes are priced in for 2026.
The European Central Bank remains haunted by the inflationary spike of 2022. At that time, the ECB estimated that inflation was transitory and was slow to react. However, as we have pointed out several times in these columns, the context is quite different from 2022. In both cases, there is an energy shock. But in 2022, we were in a post-pandemic recovery phase. Demand was strong, which exacerbated the inflationary shock.
Today, the European economy is much weaker, and rate hikes risk further dampening growth. In April, the Eurozone composite PMI stood at 48.6. This figure was well below expectations and, more importantly, signals that activity is contracting. Furthermore, last week, the German government halved its growth forecast for 2026, from 1.0% to 0.5%.
The latest ECB Survey on the Access to Finance of Enterprises (SAFE), published Monday, also shows little risk of second-round effects on inflation. Companies notably expect a slowdown in wage growth. In the markets, long-term inflation expectations (5y5y) remain anchored.
Finally, it should be noted that the magnitude of the energy shock is nevertheless smaller than in 2022. For instance, gas prices are twice as low as they were during the same period in 2022.
While the trauma of 2022 is still fresh, the ECB's history is also marked by two other monetary policy errors: 2008 and 2011. In both instances, the ECB raised rates in response to surging oil prices, only to be forced to cut them a few months later. Several economists are already anticipating that the ECB will have to lower rates after raising them. Bank of America thus expects two rate cuts from the ECB in 2027.
