The European Central Bank is expected to leave its key interest rates unchanged when it meets on Thursday, but the inflation outlook has grown murkier after renewed hostilities in the Middle East, keeping uncertainty alive over what the bank will do from September onward.
The ECB raised rates by 25 basis points on 11 June in an effort to bring inflation down, lifting the deposit rate to 2.25% from 2%, while keeping its options open for what comes next and stressing that decisions would be taken meeting by meeting based on incoming data. ECB President Christine Lagarde said at the time that the move did not mark the start of a new tightening cycle, and noted that future decisions would depend largely on how the war in Iran developed and how long the Strait of Hormuz remained closed.
Days after that meeting, the United States and Iran announced a temporary two month agreement to end the war, which included a phased reopening of the Strait to shipping. Vessel transits through the strait rose significantly afterwards, and Brent crude fell from more than $90 a barrel before the deal to $72, close to where it stood before the war began on 27 February.
Had that truce held, and had the parallel US-Iran talks moved toward a more lasting peace in the region, something that was seen as highly uncertain from the outset, the path back to the ECB's 2% inflation target would have been considerably smoother, potentially allowing the bank to limit itself to one more modest rate increase or avoid any further hikes altogether. Instead, the memorandum of understanding signed by US President Donald Trump and his Iranian counterpart Masoud Pezeshkian has since collapsed, following Tehran's attacks on vessels transiting the Strait of Hormuz and the US bombing of Iranian targets that followed. Brent prices have surged in recent days to $85 a barrel, around 20% higher than at the start of July.
The ECB will be watching closely how energy prices develop from here and how they feed through into the prices of other goods and services before making its next move. The IMF's warning adds to the sense of unease, cautioning that the factors that have so far kept oil prices from spiking further, large scale releases from strategic reserves, higher output from producers outside the Gulf, and subdued demand from China, are starting to run out.
Two data points will matter most in the weeks ahead: July inflation figures due from Eurostat at the end of the month, and August inflation figures expected on 1 September, just days before the ECB's 10 September meeting. The bank will also weigh preliminary second quarter eurozone GDP figures due on 30 July, which regularly factor into its rate decisions.
Source: CNA, AMNA
