European Central Bank (ECB) officials have indicated that even a potential US-Iran peace agreement, while possibly preventing more extreme inflation volatility, is unlikely to halt their path towards further interest rate hikes. Policymakers, including President Christine Lagarde, have welcomed the prospect of restored oil shipments through the Strait of Hormuz but emphasize that significant economic damage has already been inflicted, and they do not regret last week's decision to raise rates.
ECB Governing Council member and Slovak central bank chief Peter Kazimir stated that the scenario of elevated energy costs "could last longer than many expect," adding that "disruption in the Middle East cannot be fixed overnight, even with the newly announced peace framework." The primary issue, he noted, is the time required to restore production capacity, repair infrastructure, and resume shipping. Concurrently, efforts to rebuild inventories will keep crude oil prices elevated.
The risk for the 21-nation eurozone is that businesses may raise selling prices and workers may demand higher wages, pushing inflation significantly above the 2% target. Most analysts still anticipate further policy action, with traders betting the deposit rate will rise by at least another 25 basis points to 2.5% this year.
JPMorgan Chase & Co. economist Greg Fuzesi said the possibility of a peace deal "is taking some of the pressure off the ECB," but it does not imply a substantial reduction in the pressure to hike. Following last week's increase, he still expects another hike in September and wrote in a client note that risks are "skewed slightly toward a third hike by year-end."
Comments from several officials appear to support this view. ECB Governing Council member and Portuguese central bank governor Alvaro Santos Pereira believes the energy market situation will require time to normalize. His colleague, Latvian central bank chief Martins Kazaks, pointed out that successive, overlapping shocks have become a trend, noting "we also see that the current shock is not yet fully visible."
German central bank president Joachim Nagel added that fiscal policy measures designed to lower energy prices are set to expire, which could still push inflation higher in the coming months. "The end of the conflict does not necessarily mean the shock ends immediately," Irish central bank governor Gabriel Makhlouf said on Tuesday. "It remains to be seen when supply chains normalize and when energy prices adjust."
Analysis suggests the potential deal does not alter the outlook for the ECB's rate path, with a 25-basis-point hike in September still forecast; however, the risk to this forecast would shift to the downside if energy prices cool persistently. Uncertainty remains high, with the contours of a nuclear deal still unclear. Oil prices have fallen from around $110 per barrel at the peak of the war to below $80. Research forecasts that if a deal is finalized and implemented, prices could drop further to a range of $70 to $75 per barrel.
This level would still be above pre-war prices, and ECB Chief Economist Philip Lane expressed concern that the current reversal does not prevent further intensification of inflationary pressures. Lane stated on Tuesday that "four consecutive months of high energy prices means we can foresee inflation above 3% in the future. This will have indirect effects on food, goods, and services this year and next."
Although the ECB's baseline forecast sees price growth returning to the 2% target by 2028, Lane's preferred gauge of price pressure impact on consumers—inflation excluding energy but not food—is projected to exceed that level at least until 2028.
Goldman Sachs Group Inc. chief European economist Jari Stehn also emphasized that the ECB has a greater need to respond compared to the Federal Reserve or the Bank of England (both meeting this week). This is because, prior to the outbreak of the Iran conflict, the ECB had already lowered rates to a neutral level and must raise them to curb economic fluctuations.
Stehn added: "Historically, the ECB's response to energy shocks has also been more consistent. It typically reacts when headline inflation is significantly above the 2% target. Part of the reason is that, unlike the Fed, the ECB has a single mandate: price stability."
However, France's new central bank governor, Emmanuel Moulin, has called on his colleagues to adhere to an agreement not to pre-commit. "While there is agreement to raise rates, there is also consensus that we are not signaling the start of a new tightening cycle," he said in an interview.
Even within the economist community, some question the necessity for further hikes, or at least believe September is more suitable for an assessment than July. Spyros Andreopoulos of Thin Ice Macroeconomics said: "The deal should dampen the momentum for hikes because it raises the option value of waiting. Falling oil prices will lower headline inflation and help keep inflation expectations anchored. That should buy some time to wait for more information."
President Lagarde herself stated she would not be distracted by talks of a potential deal. "If developments in the coming days confirm the news and a memorandum of understanding is signed, that is of course good news," she said on Monday. "But I must contain inflation, because once it gets out of control, it is more difficult and costly to rein it in again, and persistent inflation is unacceptable."
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