The European Central Bank and the Bank of England are expected to keep their key interest rates unchanged on Thursday, as they await greater clarity on the duration and scope of the energy shock triggered by the Middle East conflict. At their last meeting in March, the major European central banks sent a clear signal: they were prepared to raise borrowing costs in response to soaring energy prices. This communication led investors to anticipate a series of rate hikes in the short term. In the following weeks, officials clarified their stance, emphasizing that interest rates would only be adjusted if wage pressures emerged and prices for a broad range of goods and services showed a sustained upward trend. They also indicated that the economic impact of the war would take time to become clear and that rushing to judgment could lead to policy errors. Investors have since scaled back expectations for immediate, aggressive action, but anticipate that central bank officials will reiterate their readiness to tighten policy if necessary. "The ECB should not hike rates in a rushed or panicked manner, but it undoubtedly wants to demonstrate a firm resolve to act if necessary," said Carsten Brzeski, Chief Economist at ING Bank. The conflict has already pushed inflation higher. Consumer prices in the euro zone rose 2.6% year-on-year in March, a significant acceleration from the 1.9% increase seen in February. UK inflation increased from 3% to 3.3%. With the Strait of Hormuz largely closed to shipping and energy prices remaining elevated, inflation is expected to stay above pre-war forecast levels. The Bank of England is set to release new forecasts on Thursday, and it is widely expected to follow the ECB's lead by raising its inflation projections and lowering its growth outlook. A key concern for rate-setters is that the longer the Strait remains blocked and energy prices stay high, the greater the risk of two outcomes: first, workers may demand and secure larger pay increases than sought in recent months, and second, businesses may raise prices to cover their higher costs. If these second-round effects materialize, inflation could remain stubbornly high for a longer period. For the Bank of England, at least, there is little sign yet of a significant wage surge. The bank's regional agents reported on Friday that approximately 80% of pay settlements for 2026 have been agreed upon, with an average increase of about 3.5%, only slightly above the level policymakers deem consistent with a 2% inflation target. "Currently, there is scant evidence that the Middle East situation is affecting pay," the agents stated. Conflicting signals regarding the future status of the Strait of Hormuz are complicating the decision-making process for European central bankers. At times, negotiations between the US and Iran have suggested the Strait might reopen soon. At other times, the prospect of a prolonged disruption seems more likely. "The stop-start nature of this conflict—war, ceasefire, talks, breakdown of talks, maritime blockade, lifting of blockade, re-imposition of blockade—makes assessing the duration and depth of its consequences exceptionally difficult," ECB President Christine Lagarde said in a speech last week. Policymakers' next opportunity to address the threat of persistently high inflation will come in June, by which time they will have more information on how workers and businesses are responding. "The ECB will wait and gather more information before deciding on a potential tightening of monetary policy in June," economists at Deutsche Bank wrote in a note to clients. If the Strait of Hormuz remains closed, both the ECB and the Bank of England could potentially raise their key rates, possibly even acting in tandem. The ECB is considered more likely to move first, as its key rate is currently at a level that neither restrains nor stimulates economic activity, whereas the Bank of England's rate is still seen as a drag on growth. "Compared to the ECB, we believe the Bank of England's starting point—both in terms of the economic environment and its policy stance—implies less pressure to hike rates," economists at RBC Capital Markets wrote in a client note.
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