The European Central Bank's President Christine Lagarde and the Bank of England's Governor Andrew Bailey will be busy this summer trying to move beyond the shadow of past inflation missteps while addressing persistent price pressures.
These two powerful European economic officials face a persistent dilemma: how to respond to the conflict in Iran while avoiding a repeat of the policy errors that followed the COVID-19 pandemic and the Russia-Ukraine war.
Their decisions will shape Europe's economic trajectory for years to come—and will also define their personal legacies.
With the war in Iran under US President Donald Trump pushing prices back onto an upward track, the two central banks must judge in real time what lessons to draw from their slow response in 2022, which allowed inflation to surge into double digits.
The lesson, however, is not simply to "raise rates quickly."
Paul Hollingsworth, head of developed markets economics at BNP Paribas, stated: "The problem for any central bank right now is weighing up two possible policy mistakes. One is moving slower than they should, potentially having to act more aggressively than intended later. The other is raising rates when they shouldn't have, because the actual underlying economic dynamics are very different."
Acting too slowly, policymakers risk allowing rising energy costs to seep into inflation expectations, wage demands, and the broader price-setting system, thereby undermining the credibility they have fought hard to rebuild since 2022. Acting too quickly risks choking off already fragile economic growth in response to a supply shock that may again prove transitory.
Economists expect the European Central Bank to raise rates by 25 basis points this Thursday, while the Bank of England is expected to hold steady a week later.
For both central banks, however, the key in June lies not in the size of the rate move but in the judgment behind it. For Bailey, who has less than two years left in his term, and for Lagarde—who is expected to depart before her eight-year term ends in October 2027—this decision may be remembered as prudent vigilance or another hard-learned lesson.
The decisions may appear modest, but the risks are significant.
History Repeating
After all, they have been in a similar situation before.
Both the European Central Bank and the Bank of England are still dealing with the aftermath of the inflation shock following the Russia-Ukraine war—a period for which they were criticized for reacting too slowly as inflation soared into double digits. The ECB is also haunted by its 2011 mistake: raising rates in response to an energy shock, only to be forced into a humiliating policy U-turn as the economy weakened.
Currently, eurozone inflation is at 3.2%, more than a percentage point above the ECB's target and at its highest level since 2023, while the Middle East conflict clouds the economic outlook. The ECB is expected to opt for cautious tightening. Markets anticipate two further rate hikes after Thursday's move, taking the deposit rate to 2.75% by year-end.
Thursday's decision is likely to be accompanied by higher inflation forecasts, lower growth expectations, and a warning that policymakers must remain alert to the risk of inflation becoming more deeply embedded in the economy.
BNP Paribas's Hollingsworth noted: "If you look at the ECB, it seems more concerned about repeating 2022 than 2011."
As the ECB tries to balance these two conflicting historical lessons, Lagarde is expected to keep all policy options open. Deutsche Bank economist Mark Wall said in a note to clients: "There will be no forward guidance, no pre-commitment."
Yet, while the risk of another inflationary shock is real, it is far from certain that the latest round of oil price increases will be sustained—meaning tighter policy could ultimately prove an unnecessary and costly mistake.
Holger Schmieding, an economist at Berenberg Bank, stated: "A rate hike would be a huge mistake," warning that any subsequent increases would sow the seeds for a recession.
"This is not 2022," Schmieding said. "When the economy is already being hit by higher energy costs and increased uncertainty, there is little reason for central banks to further weaken demand."
For the UK, where inflation is currently 2.8%, much has changed since the pandemic. Looking back to 2022, the jobs market was hot, the central bank kept rates low, and the government was pumping money into the economy. Now, there is almost no economic stimulus.
The apparent divergence between the Bank of England and the ECB may not be as stark as it seems. Before the latest energy price surge, many Monetary Policy Committee members had already been leaning towards cutting from the current benchmark rate of 3.75%. Therefore, holding rates steady, relative to the previous policy direction, actually amounts to a tightening.
Bailey has argued that the central bank has "a bit of time" because policy conditions have effectively tightened as mortgage rates have risen sharply with the BoE's earlier plans for rate cuts this year being shelved.
The Bank of England is also weighing signs of economic weakness, such as rising unemployment and a cooling labor market.
In Schmieding's view, given stubborn domestic price pressures after last year's rise in labor costs, the case for the Bank of England holding rates is more justified than for the ECB to hike.
But the risk—and the lingering lesson from the past—is that waiting for all the data to come in and all conditions to be met may be too late to prevent a surge in prices.
BNP Paribas's Hollingsworth, speaking about the Middle East conflict, concluded: "The shock has now lasted long enough. The question is no longer whether central banks need to respond, but how much and when."
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