Escalating military exchanges between the United States and Iran over recent days have thrust oil prices back into the spotlight, simultaneously introducing fresh uncertainties for the European Central Bank's upcoming interest rate decision.
European Central Bank policymakers are recalibrating their expectations for the July 22 monetary policy meeting, as a sharp spike in oil prices on Wednesday casts doubt on prior assumptions of steady rates.
Bundesbank President and ECB rate-setter Joachim Nagel told Reuters on Wednesday that the renewed conflict in the Middle East and the associated surge in oil prices "underline that the situation remains extremely volatile and uncertainty is equally high."
He added, "A cautious approach remains advisable, but we must act decisively when necessary. Monetary policy will remain vigilant."
ECB's Policy Reversal
The ECB had lowered its key deposit rate four times in the first half of 2025, reducing it from 3% at the start of the year to 2% by mid-June. However, last month, the central bank was compelled to reverse course, raising rates by 25 basis points to the current level of 2.25%.
Before the outbreak of the Iran war, headline inflation was hovering near the ECB's 2% target, before accelerating to a peak of 3.2% in May. Preliminary estimates show that, despite energy costs rising 8.7% year-on-year last month, eurozone inflation eased to 2.8%, with core inflation contained at 2.4%—suggesting limited "second-round" inflationary effects from other parts of the economy.
Yet energy prices have surged again this week, as days of conflict between the US and Iran over control of the strategically vital Strait of Hormuz have reignited concerns over oil supply. The price of the international benchmark Brent crude for September delivery moved higher again in early Wednesday trading, surpassing $85 per barrel. Just last week, it was trading closer to pre-war levels, around $70 per barrel.
Oil prices are critically important for the eurozone economy. According to the latest available data from Eurostat, 57% of the euro area's energy needs were met by imports in 2024.
Policymakers will also proceed cautiously, wary that an overly restrictive monetary policy stance could push the eurozone economy into recession. The eurozone economy contracted by 0.2% year-on-year in the first quarter of 2026.
Eurozone Inflation Peak "May Not Yet Be Visible"
Policymakers will also note that preliminary estimates for second-quarter GDP growth and July inflation data will not be released until July 30 and July 31, respectively. This means next week's rate decision will be made without access to the most recent figures.
ING rate strategists Michele Tuke and Benjamin Schroeder wrote in a report on Wednesday that eurozone inflation data "will be crucial to challenge the market's hawkish positioning," but "even then, these data are unlikely to put markets at ease on second-round risks."
They stated, "All this uncertainty means the market's expectations for ECB pricing are likely to continue diverging from the Fed. Inflation momentum in the US should be downwards, while in Europe the inflation peak may not yet be visible, especially if energy prices continue to move higher."
Last month's decline in oil prices had led investors to virtually rule out an ECB rate hike next week. Current market pricing still shows only about a 20% probability of a hike. However, investors still anticipate two further 25-basis-point hikes by next spring, which would bring the ECB's key deposit rate to 2.75%.
Austrian National Bank Governor Martin Kocher told the German newspaper Boersen-Zeitung on Wednesday, "At the moment, we are paying particular attention to the indirect price effects of the war in the Middle East and possible second-round effects. We are not seeing second-round effects at present, but we also have to align our monetary policy with inflation expectations."
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