The European Central Bank (ECB) kept the deposit facility rate unchanged at 2% for the sixth consecutive meeting on Thursday, in line with market expectations, while attempting to assess the impact of the Middle East conflict on inflation and the economy.
The ECB maintained the deposit facility rate at 2% for the sixth consecutive meeting on Thursday while trying to evaluate the impact of the Middle East war on inflation and the economy, which met market expectations. Policymakers once again refrained from providing guidance on future policy paths, reiterating that decisions will be made on a meeting-by-meeting basis according to the latest data.
However, the ECB adopted a tougher tone regarding risks facing the Eurozone. In its statement, the ECB said: "The war in the Middle East has made the outlook more uncertain, bringing upside risks to inflation and downside risks to economic growth." "The conflict will have a material impact on short-term inflation through higher energy prices. The medium-term effects will depend on the intensity and duration of the conflict, as well as how energy prices feed into consumer prices and the broader economy."
As the situation in the Middle East continues to deteriorate, the fighting has spread to multiple energy infrastructures in the region. The latest shock to oil and gas markets has prompted investors to bet that the ECB will have to raise borrowing costs this year. The severity of Europe’s exposure to the conflict will depend on the duration of the war—the biggest uncertainty factor. The EU warned that if Brent crude prices remain near $100 per barrel and natural gas prices stay elevated for an extended period, inflation could exceed 3% by 2026. Some economists even believe that if the issue persists, inflation may rise above 4%.
In addition, the ECB's latest quarterly outlook shows faster inflation and slower growth. The ECB noted that a separate scenario analysis indicates that “if there are prolonged disruptions to oil and gas supplies, inflation will be higher than the baseline forecast, while economic growth will be lower.” However, analysts suggested that the value of this latest outlook may be limited, as much of the input data predates the outbreak of the Middle East conflict.
Compared to the onset of the Russia-Ukraine conflict in 2022, ECB policymakers currently have more room to maneuver. However, some are already raising the possibility of interest rate hikes—even as economic output shows signs of fragility, sparking concerns about stagflation.
ECB President Lagarde will present her views at a press conference at 2:45 PM local time. While Lagarde and other ECB officials have emphasized that they will not allow a repeat of the previous inflation shock, most also oppose hasty actions. They pointed out that the current situation differs from four years ago, when pent-up demand released after the pandemic drove up demand, and borrowing costs were below zero.
Investors currently expect the ECB to implement more than two interest rate hikes of 25 basis points each this year. However, economists are divided, with the consensus expecting no changes until 2027.
Editor/Doris