Central banks across Europe held interest rates steady on Thursday but policymakers signaled they are prepared to raise interest rates to curb inflation driven by the conflict in the Middle East.
The key point
The European Central Bank and its counterparts in the U.K., Switzerland and Sweden all left rates unchanged, as widely expected by markets. That follows the Federal Reserve's decision to keep rates steady a day earlier. The Bank of Canada and the Bank of Japan have made the same call this week.
The escalating war in the Middle East is weighing on the outlook for the global economy. Europe, which depends heavily on imported energy, is seen as particularly vulnerable to disruptions in oil and gas production in the Middle East.
Central bankers have stressed that it is too early to say how higher energy costs will impact growth and inflation. But investors are beginning to brace for a longer-lasting disruption to energy supplies that would pose a larger threat to the economy.
The BOE signaled Thursday it that it was prepared to raise rates if the war's impact on inflation is persistent. It added it won't rush into a move as the duration and scale of the disruption to energy supplies remain uncertain.
"I will be monitoring developments extremely closely and stand ready to act as necessary to ensure inflation remains on track to meet the 2% target," said Gov. Andrew Bailey.
The context
For central bankers in Europe, the key question is how long higher energy costs will last, and what impact it will have on the prices of other goods and services.
The conventional response to a supply shock is to look past it, with the expectation that price spikes are often short-lived and raising interest rates will hurt growth more than they help contain inflation.
But European policymakers have been chastened by a surge in energy and food prices following Russia's full-scale invasion of Ukraine in 2020. That led to a jump in wage demands, and higher prices for a range of labor-intensive services. As a result, inflation stayed above their target for longer than they had expected.
They worry that memories of that experience mean workers will be quick to demand higher wages this time around, triggering another round of price rises for services.
Goldman Sachs lifted its inflation forecasts for both the eurozone and U.K. last week, calling for a peak rate just under 3% later in the year. But the bank isn't expecting energy costs to feed through to other prices, unless energy disruptions get worse.
What's next
Investors are betting both the ECB and BOE will raise rates at least twice this year, according to LSEG data. Ahead of the Iran conflict, investors had largely expected the ECB to stay on hold this year and the BOE to keep cutting rates.
The BOE removed a phrase from its statement that signaled further cuts in its key rate, although a swift end to the war and the disruption to energy supplies could revive calls for lower borrowing costs.
