The ECB does not want to repeat the mistake of 2022 and is now reluctant to treat the price spike caused by the Iran war as temporary. With oil prices up 20% and Qatar’s LNG supply disrupted, the European central bank is now better prepared to respond to imported inflation threatening the eurozone.
Although monetary policy is now tighter than two years ago, domestic inflation is still above the 2% target. Fears that inflation will become “recalcitrant” have led policymakers to lower the threshold for raising interest rates to avoid further damage to credibility.
The main dilemma facing it is whether rising energy prices will cause continued inflation or actually stunt economic growth (deflation). So far, there is a difference of opinion between committee members who want flexibility and those who want to see the real impact of the war first.
Markets are now pricing in a 20-30% probability of an interest rate hike this year. The ECB's decision in March is expected to set a new direction, where price stability will be prioritized over the risk of economic slowdown for the time being.
