A member of the European Central Bank's Governing Council, Peter Kazimir, indicated that the war involving Iran and its inflationary impact may compel the ECB to raise interest rates sooner than anticipated. Although the ECB remains in a favorable position with no immediate action required at next week's meeting, Kazimir expressed concern that memories of the 2022 inflation shock in the region have lowered the threshold for businesses to increase prices and for consumers to demand higher wages. He stated that upside risks clearly dominate the outlook. In an interview on Tuesday, Kazimir remarked, "We currently need to remain calm," while adding, "I believe the ECB's response could come sooner than many expect." He declined to speculate on April or June but emphasized readiness to act if necessary.
Traders are betting that surging energy costs resulting from Middle East conflicts will prompt the ECB to raise rates this year—despite the U.S. President's statement that the war may end "soon." Fresh memories of Europe's 2022 price surge have raised concerns about a resurgence of inflation. Kazimir's comments led investors to increase bets on monetary tightening, with market pricing now indicating a 60% probability of a rate hike in June and around a 35% chance of another hike by year-end. Policy-sensitive short-term bonds led declines in German government debt, with the two-year yield climbing 9 basis points to 2.35%. The Stoxx Europe 600 index fell 0.9%.
ECB officials are aware that progress toward restoring price stability is under threat. However, they currently urge patience in assessing the consequences of actions targeting Iran, which could also weaken economic growth. Traders have increased bets on ECB rate hikes due to the Iran conflict. ECB President Christine Lagarde stated on Tuesday evening that officials will ensure the conflict does not inflict inflation pain on Europe comparable to that seen after Russia's invasion of Ukraine. In an interview, she said, "We will do everything necessary to ensure inflation remains controlled and that Europeans do not experience the kind of price surges witnessed in 2022 and 2023."
Kazimir, who also serves as Slovakia's central bank governor, hinted that even before the Iran conflict, he was dissatisfied with current conditions due to sticky service prices, insufficiently slowing goods costs, and expanding profit margins. His concerns have since heightened. "The balance of inflation risks has clearly shifted to the upside," he noted. "We can forget all discussions about inflation falling below target." Kazimir pointed to rising expectations as an early indicator of long-term price shock consequences. "Businesses still remember the inflationary period and may pass on high costs to consumers much faster than in 2022," he said. "People will also demand wage increases more quickly than before."
Signs of such second-round effects could justify interest rate hikes. Policymakers appear better prepared than in 2022, when lingering effects of quantitative easing and commitments to accommodative policy constrained their actions. "If necessary, we can react more swiftly," Kazimir affirmed. "We must remain agile. We have learned lessons." He indicated that quarterly ECB forecasts, due this month and in June, are not prerequisites for action. "I have no objection to raising rates without new projections. What is clear is that further rate cuts are absolutely off the table for now."
Kazimir's emphasis on agility was echoed by colleagues. Bundesbank President Joachim Nagel reiterated his support for a "wait-and-see approach" but affirmed the ECB's readiness to intervene if needed. In an interview published Wednesday, he stated, "If it becomes evident that current energy price increases will translate into broad consumer price inflation over the medium term, the ECB Governing Council will act in a timely and decisive manner." Meanwhile, Banque de France Governor François Villeroy de Galhau remarked, "As things stand, I do not believe we should raise rates now." ECB Vice President Luis de Guindos noted that the war's impact on Europe will depend on its duration and intensity.
Despite uncertainties, Kazimir remains "fairly optimistic" about growth and is not "overly concerned" about stagflation. He cautioned governments against implementing costly relief measures to shield consumers and businesses from high energy costs, citing unstable fiscal conditions in some member states. "There is no doubt governments will seek to provide at least some relief," he said. "I strongly advise against this and encourage targeted, time-limited measures instead—though such discipline has rarely been observed in the past."
Kazimir expressed confidence that Lagarde will complete her term, dismissing speculation about an early departure. He stated that Lagarde "has made it clear she is committed to serving her full term—that is a fairly explicit message for us. If something changes later, that is fine; we will handle it. But now is not the time for speculation." He added that European institutions require stable leadership at this juncture, noting that "uncertainty over someone's presence is not helpful."
Comments