ECB policymaker Elderson warned that a prolonged Middle East conflict increases the likelihood of second-round inflation effects, where higher energy costs spread to wages and other economic sectors. While he sees no clear evidence of this yet, the risk reinforces expectations of a June rate hike. Inflation remains above the ECB's 2% target.
The ECB faces a delicate balancing act between controlling inflation and supporting a weakening economy. Persistent geopolitical risks in the Middle East threaten to keep energy prices high, potentially forcing the ECB to tighten policy further, which could exacerbate economic slowdowns.
ECB policymaker Elderson warned that a prolonged conflict in the Middle East significantly increases the likelihood of second-round inflation effects, where initial energy price shocks evolve into broader and more persistent price pressures across wages, services, and other economic sectors. He emphasized that while he is not currently observing clear evidence of these second-round effects, the ongoing situation reinforces expectations for the ECB to raise interest rates at its June meeting. The euro area's inflation rate had accelerated to 3.2% in May, with core inflation rising to 2.5%, indicating that price pressures remain above the ECB's 2% target despite a weakening economy. Markets are largely anticipating a 25 basis point rate hike in June, with expectations for at least one additional hike before the end of the year. The geopolitical backdrop continues to be dominated by the US-Iran conflict and ongoing disruptions in energy markets, keeping oil prices substantially above pre-war levels due to persistent uncertainty surrounding shipping routes like the Strait of Hormuz. ECB officials are increasingly concerned that sustained high energy prices could lead businesses to pass costs to consumers and workers to seek higher wages. Recent discussions within the Governing Council have acknowledged differences from the 2022 energy shock, noting more anchored inflation expectations, weaker demand, and less intense labor market pressures. However, policymakers have consistently cautioned that the risk of second-round effects escalates significantly if the conflict endures and energy prices remain elevated. A key concern for ECB policymakers is maintaining credibility; many argue that delaying action until second-round effects are evident risks repeating past inflation mistakes. Consequently, the anticipated June rate increase is increasingly viewed as a proactive measure to prevent temporary, energy-driven inflation from becoming entrenched in the broader economy.
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