The European Central Bank is navigating an increasingly narrow policy path, caught between inflation pressures stoked by geopolitical conflict and economic growth hampered by energy shocks.
Inflation remains stubbornly high, with market forecasts now pointing to two interest rate hikes this year. A recent survey of economists, conducted from May 4th to 7th, indicates a worsening inflation outlook for the eurozone. Driven by the war in Iran pushing up energy prices, inflation in 2026 is now expected to accelerate to 2.9%, up from a previous forecast of 2.8%. Analysts project that inflation will only return to the ECB's 2% target by 2028. Consequently, economists anticipate the ECB will raise interest rates twice this year—by 25 basis points each in June and September. This outlook contrasts with earlier market expectations of just one hike, suggesting the deposit rate will rise from its current level of 2%.
Growth alarms are sounding, making "prudence" the watchword. However, the prospects for the real economy are moving in the opposite direction of inflation. Analysts have downgraded their 2026 eurozone growth forecast from 0.9% to 0.8%, with subsequent years expected to see growth of 1.3% and 1.5% respectively. ECB Vice President Luis de Guindos stated plainly in an interview that upcoming economic activity data "will not look good." He noted that energy shocks are reflected in inflation indicators much faster than in growth metrics, and their drag on growth will become more apparent in the coming weeks. Guindos therefore urged "prudence" in interest rate decisions. He emphasized that even if a ceasefire is reached soon, the conflict will leave "scars"—with some infrastructure already destroyed and consumer confidence already declining. "Key indicators are already falling," Guindos warned. "Whatever the specific factor pushing up energy prices, its impact on confidence is sometimes underestimated by us."
Internal divisions exist within the governing council, with the Strait of Hormuz a focal point. While Guindos declined to "prejudge the interest rate decision," he repeatedly mentioned in the interview that whether the Strait of Hormuz reopens will be a "very important" consideration at the June meeting. Clear differences of opinion are evident within the ECB. Slovak National Bank Governor Peter Kazimir believes a June rate hike is "almost inevitable"; Bundesbank President Joachim Nagel also stated that action will be taken unless the economic outlook "improves significantly." Other policymakers, however, are more cautious, stressing the need to assess more data. ECB President Christine Lagarde captured the essence of the dilemma: "We have always been caught between the risk of acting too early and acting too late. We must find the right path."
Beneath the market's calm surface, undercurrents are swirling. Notably, Guindos views the financial markets' "fairly calm" reaction as a positive signal—a significant repricing of asset markets "would be very harmful, amplifying the impact of the energy shock." He also assessed the wage situation as "stable" and inflation expectations as showing "no signs of unease so far." However, whether this calm persists depends on developments regarding the Strait of Hormuz and the trajectory of the Middle East conflict. As Guindos put it: "Let's see the data, the forecasts, and the evolution of the conflict in the coming weeks."
Overall, the ECB stands at a delicate crossroads: acting too late risks letting inflation become unanchored, while acting too quickly could crush an already fragile economy. In the lead-up to the June meeting, perhaps the scarcest resource for policymakers is certainty about the conflict's future path.
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