Key Points
Both the European Central Bank and the Bank of England are scheduled to announce their monetary policy decisions on Thursday. Inflation in Europe has surged again, driven higher by rising fuel prices due to the conflict involving Iran. Signs are emerging in both the Eurozone and the UK: economic growth, along with business and consumer confidence, is being impacted by the war.
This week, global attention is focused on the European Central Bank's next move. Against a backdrop of rising prices and growing concerns about economic growth, the ECB and the Bank of England will announce their latest monetary policy decisions. Economic data from March for the Eurozone and the UK indicate that the conflict involving Iran is beginning to weigh on the economy, raising market fears that stagflation risks are approaching. Stagflation refers to the simultaneous occurrence of low economic growth, high inflation, and rising unemployment. When the war initially impacted the global economy, both the ECB and the Bank of England held interest rates steady at their March meetings. Markets widely expect both central banks to maintain a cautious stance this Thursday. Following the outbreak of the conflict, markets initially quickly priced in imminent rate hikes from both banks. However, economists now believe policymakers will look past this short-term inflationary disturbance and keep rates unchanged for a longer period. The ECB's benchmark rate is held at 2%, and the Bank of England's rate is at 3.75%. Current inflation rates are 2.5% in the Eurozone and 3.3% in the UK, both above the central banks' 2% inflation target. Oliver Rakau, Chief German Economist at Oxford Economics, stated via email to CNBC: "Energy price increases have not yet significantly exceeded the ECB's forecast baseline, and with negotiations involving the US and Iran still ongoing, there is a general tendency to believe the conflict will not be prolonged." He added, "Surveys show this economic shock is arriving more concentrated and front-loaded compared to 2022, and concerns about secondary inflation effects have cooled."
Secondary effects refer to the indirect chain reactions from a sudden inflationary shock, such as workers demanding higher wages and businesses raising prices broadly. These effects are often sticky and difficult for central banks to suppress quickly with monetary policy. Rakau further noted that only sufficiently clear evidence of secondary effects would force the ECB to act, although the threshold for triggering a rate hike is not particularly high. "We expect that rising inflation expectations, a resilient labor market, manageable economic damage, and an acceleration in core inflation will trigger consecutive ECB rate hikes in June and July. Moderately tightening policy could both cushion the economic impact and curb the risk of secondary inflation spreading." On Thursday, markets will closely watch the ECB's forward guidance. ECB President Christine Lagarde stated at last month's meeting that the central bank is prepared to raise rates even if the current inflation spike in the Eurozone proves temporary. Economists generally view the June meeting as the key event, where the ECB might raise rates by 25 basis points, bringing the benchmark rate to 2.25%. In a pre-meeting analysis, economists at BNP Paribas indicated that the ECB's Governing Council wishes to retain the option to hike rates later. "Therefore, holding steady in April does not mean no tightening is needed, but rather current data does not yet support immediate action. Unless energy prices see a significant and sustained short-term decline—which is not our baseline forecast—a 25 basis point hike in June is highly likely." However, BNP Paribas believes the ECB will not pre-commit to a hike nor signal a strong inclination to tighten. "It is more likely to emphasize that it is currently in a favorable wait-and-see position, continuing its recent slightly dovish communication tone." José García Cantero, Chief Financial Officer at Santander, stated on Wednesday during an appearance on a financial program that significant rate hikes in Europe are unlikely in the short term. "Central banks are currently choosing to pause. While there is a tendency to hike in Europe, it will be implemented very gently. The ECB's previous success in curbing inflation means subsequent hikes will be very measured." Bank of England's Dilemma The outbreak of the conflict involving Iran in late February completely disrupted the Bank of England's previous forecasts, which anticipated a gradual cooling of inflation back towards the 2% target. The Bank of England predicted in March that, due to higher energy prices, inflation could peak between 3% and 3.5% in the second and third quarters of 2026. It also warned that war-related uncertainty significantly complicates economic forecasting. Latest data shows UK inflation rose to 3.3% in the year to March, up from the previous 3%. Markets had initially expected multiple rate cuts from the UK in 2026, but expectations reversed sharply after the conflict, shifting to predictions of potential rate hikes within the year. However, expectations for hikes have since cooled considerably. Economists widely believe the Bank of England's Monetary Policy Committee, led by Governor Andrew Bailey, will exercise extreme caution. A Reuters poll last week found that a majority of economists expect the Bank of England to keep rates unchanged for the remainder of the year. Policymakers are inclined to view the externally-driven inflation surge as a temporary disturbance and opt for patience. The central bank is also concerned that hiking rates prematurely could exacerbate stagflation risks.
For this week's meeting, most economists expect the vote to be 8-1 in favor of holding rates steady, with the lone dissenter likely being hawkish committee member and Chief Economist Huw Pill. Bruna Skarica, Chief UK Economist at Morgan Stanley, and strategist Fabio Bassanin stated that markets are looking for clear and simple policy signals and a strategic framework from the Bank of England. "Based on rhetoric, the Bank is likely to only provide guidance that it stands ready to act if secondary inflation risks intensify. Compared to March, it will likely place more emphasis on the impact of tightening policy on economic growth, indicating more cautious policy considerations." Analysts noted, "The surge in commodity prices boosting inflation is a given. The real dilemma is whether to use tightening policy to bring inflation back to the 2% target faster, while accepting the cost of slower economic growth." Suren Thiru, Chief Economist at the Institute of Chartered Accountants in England and Wales, believes the meeting is almost certain to result in no policy change. "Stagflation concerns will loom over the entire meeting, and high inflation pressures might prompt at least one hawkish member to vote for a hike as an exception." He added, "With global headwinds intensifying, the difficulty for policymakers has increased significantly. Weaker wage growth and an economic slowdown suppressing overall demand provide enough room for policymakers to hold steady temporarily, even during a period of high inflation."
Comments