Following the European Central Bank's (ECB) expected interest rate hike on Thursday, ECB Governing Council member and Bundesbank President Joachim Nagel indicated on Friday that the central bank stands ready to raise rates again at its next policy meeting in July if necessary. This stance contrasted with the more cautious approach of other ECB officials regarding the future policy path.
Nagel stated that the impact of the conflict in Iran was too severe, making the rate hike this Thursday necessary even if the situation were to ease quickly. He noted that high energy costs are having a cascading effect on other prices and influencing the core inflation rate. In an email on Friday, Nagel said, "The Governing Council will hold its next monetary policy meeting in July. We are keeping all options open and remain ready to act again if necessary. Our data-dependent, meeting-by-meeting approach remains appropriate."
Irani Conflict Fuels Inflation, Prompting ECB's First Hike in Three Years
The ECB raised its key deposit facility rate by 25 basis points on Thursday, moving it from 2% to 2.25%. This marked the central bank's first rate increase in three years. The ECB concluded that, with inflationary pressures intensifying, it could no longer afford to wait for the Middle Eastern conflict to conclude before taking action. This move made the ECB the first major central bank globally to respond to the inflation triggered by the Irani war.
The ECB reiterated that it would not pre-commit to a specific future policy path and affirmed its capacity to navigate the current highly uncertain environment. The war's effects are becoming increasingly evident in Europe, with consumer prices rising by more than 3% in May and business activity remaining persistently weak.
ECB President Christine Lagarde warned on Thursday that the energy shock is "spreading" through the economy. Market expectations are for the ECB to implement two more 25-basis-point rate hikes to curb rising prices. According to informed sources, if conditions do not improve, the next hike could come as early as July.
Hours after the ECB's decision, the International Monetary Fund (IMF) stated that further policy tightening is necessary to control prices, regardless of timing. IMF staff noted, "Policy interest rates need to be raised to contain the impact of the shock on inflation." The Fund's outlook assumes a cumulative 50-basis-point increase in ECB rates this year to address the risk of both headline and core inflation exceeding 2% by 2028.
The ECB's quarterly projections released this week indicate that consumer price increases will accelerate over the next two years, while economic growth will be hampered by weak demand.
Nagel's Hawkish Tone Contrasts with Colleagues' Cautious Stance
Nagel stated that the inflation outlook had "deteriorated further" and that the shock was proving "strong and persistent." He remarked, "That is why we cannot look the other way. A rate hike was necessary even in the event of a rapid easing of the situation."
Other Governing Council members also spoke following the rate decision but avoided making definitive statements about the future policy direction. Shortly after Thursday's announcement, ECB Governing Council member and Bank of Slovenia Governor Bostjan Vasle stated that the hike was necessary to contain price increases while officials consider the broader implications of the Middle Eastern conflict. "For now, it is enough to proceed along our main path," he noted, adding that while the previous two meetings lacked sufficient evidence for a hike, the solid data now available clearly shows "inflation will be higher and growth will be lower."
Vasle did not provide any hints about the next steps, merely reiterating the ECB's official stance that decisions are data-dependent. He also countered some analysts' views that hiking rates amid a weak economy could be a mistake, stating, "We have a very solid set of data." Even if the Strait of Hormuz were to open quickly and oil prices were to fall rapidly, crude oil would not be immediately available everywhere, and "this effect will last for some time."
His Estonian counterpart, Madis Muller, was similarly cautious, stating it is difficult to predict when the ECB might next raise borrowing costs. Muller said, "There are many uncertainties. For instance, we raised rates this time but not last time because we had been hoping this conflict might be resolved." He emphasized, "If we take a more realistic view, the risks to inflation are more skewed to the upside."
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