Hot on the heels of hawkish BoE communications which destabilized the UK front-end, stoking still more unease across already anxious global markets, the ECB voiced considerable consternation about the war’s impact on inflation in Europe.
Rates were left unchanged on Thursday, as expected, but the new ECB statement emphasized right up front that the GC’s “determined” the energy shock won’t reverse the progress made restoring inflation to target in recent years.
The ECB had the most success in arresting runaway price growth in 2022 and 2023. As the figure below reminds you, inflation — both headline and core — has been close enough to target since May, when the underlying measure ticked down to 2.3%.
Ignoring the fact that something’s gone terribly awry if annual inflation across a collection of mostly-developed economies accelerates to 10%, that chart’s “picture perfect” to the extent it suggests taming runaway price growth’s as simple as raising rates.
Without subjecting you to a belabored recap of recent history, it’s not that simple. The ECB was lucky in a lot of important respects, and this was one case where Europe’s moribund growth profile was actually a blessing.
On Thursday, the bank said the war “has made the outlook significantly more uncertain, creating upside risks for inflation and downside risks for economic growth.”
The statement described “a material impact on near-term inflation” from higher energy prices and stated the obvious about anything beyond the near-term: The future’s unknowable and depends “both on the intensity and duration of the conflict.”
Notably, ECB staff made an exception for the war by extending the cutoff period for the new projections to March 11. The headline inflation forecast was marked up to 2.6% this year “because energy prices will be higher owing to the war.”
The core inflation projection for 2026 was also bumped up “mainly owing to higher energy prices feeding into inflation excluding energy and food,” staff went on. The growth outlook for this year was marked down to reflect a drag from the war on “real incomes and confidence.”
If that all sounds like bad news, that’s because it is. The silver lining is that, as the GC put it, the ECB’s “well positioned to navigate this uncertainty.”
That’s actually a semblance of true. So don’t scoff or if you do, make it an attenuated scoff compared to what you might emit when the Fed says the same thing.
As noted above, inflation in Europe was tame headed into the war and the ECB has ample scope to hike or cut rates. They’re right at neutral and thanks to modern history’s worst policy mistake (Jean-Claude Trichet’s infamous July 2008 rate hike), they’ll presumably think long and hard about any decision to tighten.
Still, Europe’s very vulnerable here. With allowances for the fact that the war in Ukraine woke policymakers up to the perils of energy dependence, being apprised of a risk isn’t the same as being prepared to respond. And fiscal breathing room isn’t something the bloc’s major economies have in abundance save Germany, which has already pivoted towards more spending (primarily for defense).
ECB staff conducted an analysis for this week’s meeting in an effort to “assess how the war in the Middle East could affect economic growth and inflation under some alternative illustrative scenarios.” In the case of “a prolonged disruption in the supply of oil and gas,” inflation in Europe would run above the baseline, and growth below it.
Don’t worry, though. As the statement noted, “The Governing Council is closely monitoring the situation.” Markets now expect two rate hikes from the ECB in 2026.
