European Central Bank Governing Council member and Latvian central bank governor Martins Kazaks stated on Thursday that the ECB may be compelled to raise borrowing costs if rising crude oil prices feed into inflation expectations. Kazaks remarked, "Oil prices have increased, and we are observing their gradual push on inflation. If inflation expectations begin to deteriorate, the ECB will be forced to raise interest rates." Markets widely anticipate a 25 basis point rate hike by the ECB at its June meeting. Some officials have indicated they have sufficient data to support such a move, while others believe further economic weakening is necessary before acting. Kazaks commented, "Financial markets have currently priced in a rate hike—I can neither confirm nor deny this. We will observe developments. However, looking at scenario analyses and forecasts, the current situation is more severe than the initial predictions under the baseline scenario."
The shadow of "stagflation" looms as several ECB Governing Council members have recently issued hawkish statements. Prior to Kazaks' remarks, ECB Governing Council member and Bundesbank President Joachim Nagel stated on Wednesday that the probability of the ECB needing to raise rates is increasing due to impacts from the situation in Iran. Nagel said, "I still hold a glimmer of hope for a significant easing of the Middle East situation—but we cannot ignore high energy prices," adding, "Unless there is a fundamental change in the inflation situation, a rate hike is becoming increasingly likely." He further warned, "We may still face considerable inflationary pressure in the future."
ECB Governing Council member and Bank of Finland Governor Olli Rehn warned on Wednesday that the evolving situation in Iran, coupled with rising energy prices, is showing early signs of stagflation in eurozone data. Rehn noted, "Relevant signs are beginning to appear in statistical data. Eurozone economic growth in the first quarter was only slightly above zero, while inflation accelerated to 3%." He emphasized that the current shock is not as severe as the previous price surge in 2022, but developments have deviated from the ECB's baseline expectations and are "moving towards a less optimistic scenario, at least in terms of oil prices."
Reports indicate that the specter of "stagflation" is overshadowing the eurozone economy, continuously constraining the ECB's policy space. On one hand, the Middle East situation is driving up international oil prices and intensifying inflationary pressures in Europe. On the other hand, slowing European economic growth and persistently weakening market confidence limit the scope for further rate hikes. Data shows that eurozone inflation rose to 3% in April, the fastest pace since autumn 2023, up from 2.6% in March. Simultaneously, eurozone first-quarter GDP grew by only 0.1%, below expectations, indicating a challenging growth outlook.
ECB Vice President Luis de Guindos stated bluntly that upcoming economic activity data "will not look good," urging "prudence" in interest rate decisions. He stressed that even if a ceasefire agreement is reached soon, the conflict will leave "scars"—some infrastructure has been destroyed, and consumer confidence has already declined. Currently, economists expect the ECB to implement two rate hikes this year—25 basis points each in June and September—aligning more closely with market expectations that the ECB will act at least twice this year.
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