Inflationary pressures are once again clouding the Eurozone outlook! As a new wave of inflation hits, will the European Central Bank signal tonight its intention to pull the trigger on an interest rate hike as early as June? The ECB is scheduled to announce its interest rate decision at 20:15 Beijing Time on Thursday. Aligning with the stance of other major global central banks this week, the ECB is almost certain to keep interest rates unchanged. However, policymakers are likely to simultaneously send a clear signal that the window for raising rates could open as soon as June, in response to surging energy prices and escalating inflation triggered by the conflict involving Iran. Since the outbreak of the conflict, the Eurozone's inflation rate has remained significantly above the central bank's 2% target. Officials are closely monitoring whether price pressures are embedding themselves into the real economy, potentially creating second-round effects that could entrench high inflation in a self-reinforcing cycle. So far, however, these secondary effects have not become clearly evident. The services sector, previously a core driver of price increases, has cooled more than some expected. This has reduced the pressure for immediate action from the ECB, giving policymakers more time to analyze economic data that has not yet fully reflected the impact of the conflict. Investors are already betting that the ECB will act in June, followed by two additional rate hikes later in the year. Hopes for peace involving Iran are fading, while oil prices have surpassed $110 per barrel, approaching levels envisioned in the ECB's "worst-case" scenarios. According to Jens Eisenschmidt, an economist at Morgan Stanley, the ECB's core intention is to send a signal to price and wage setters: "We are highly vigilant and will not allow inflation to take root." He added, "These rate hikes will not fundamentally alter the overall interest rate environment," noting their effect would essentially be "just pushing the deposit rate from a roughly neutral level to the upper end of the neutral range." At 20:45 Beijing Time, ECB President Christine Lagarde will hold a monetary policy press conference, with investors closely watching her remarks. During the previous press conference, she indicated that policymakers were prepared to raise rates even if the surge in Eurozone inflation expectations ultimately proved temporary. Rapid Economic Slowdown Creates Policy Dilemma However, as expectations for rate hikes intensify, the rapid slowdown in European economic growth has placed the ECB in a dilemma between curbing inflation and protecting growth. A series of survey data released this week has issued multiple warnings: business confidence is declining faster than expected, service sector sentiment is deteriorating, corporate profits continue to shrink, exports struggle under tariff pressures, and major banks plan to tighten credit to businesses. Any move to raise interest rates could further stifle already fragile economic momentum, even increasing the risk of dragging the entire Eurozone into a recession. Yet the same surveys also indicate that both consumers and businesses expect inflation to accelerate further. Data released hours before the ECB's policy decision is expected to show the Eurozone's April inflation rate climbed to 2.9% from 2.6% in March, far exceeding the central bank's target. Luigi Speranza, Chief Economist at BNP Paribas, stated plainly: "The probability of second-round effects is very high. The possibility that increases in energy and food prices transmit to core inflation in a more perceptible way is indeed extremely high." A Wait-and-See Approach Informed by Historical Lessons Faced with this situation, policymakers may not be in a hurry to act immediately. This week, the US Federal Reserve, Bank of Japan, and Bank of Canada have all chosen to keep rates steady, with the Bank of England expected to do the same. ECB officials have previously indicated that the brief six-week interval between two policy meetings is unlikely to yield substantial differences, making it a safer choice to wait for more conclusive data before truly "pulling the trigger" on rate hikes. Thierry Wizman, FX and Rates Strategist at Macquarie, suggested that policymakers are "certainly paying increasing attention to the war's impact on achieving inflation targets, but this will not lead most participants to change policy settings this week." This assessment is crucial because the current inflationary wave is fundamentally different from the major outbreak in 2022, a period for which the ECB was widely criticized for acting too slowly. In 2022, inflation levels were much higher, interest rates were still deeply negative, government budgets were loose, the labor market was tighter, and households held significant pandemic-era savings ready to be spent. Today's environment is markedly different. Nomura's assessment concludes: "We believe that if, by the time of the ECB's June meeting, the spot price of Brent crude remains stubbornly above $95 per barrel, then the ECB will hike rates by 25 basis points in June and implement another hike in September." The institution further noted that Governing Council members need to first confirm whether the current shock leads to persistently high inflation, as in 2022, or significantly raises inflation expectations, before truly deciding to initiate a rate hike cycle.
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