Growth has felt the drag through both confidence and real incomes, with the euro area composite purchasing managers’ survey shrinking in April – for a first time since 2024.
A core focus of policy makers remains rightfully on expectations—once households and firms begin to believe inflation is back, they behave in ways that make it so. As Brent crude prices stay above USD 100 a barrel, there are signs of increasing inflation expectations in gauges of households and firms. In that sense, the war’s effects may be the most apparent in a shifting balance of risks: away from disinflation, and back toward persistence. We are likely operating already somewhere between a benign baseline scenario of the European Central Bank and an adverse scenario of the Bank—and within that grey zone, the asymmetry is clear: growth risks skew down, inflation risks skew up.
As I recently commented for a Bloomberg panel of economists – the ECB’s threshold for eventually responding may be lower than it may appear to many. The next move in official rates is more likely to be a hike than a cut, even if conditions remain fluid. It does not require the proof of a wage spiral; it only needs a credible risk of one. Even though a relatively benign path—whereby inflation expectations stay broadly anchored—would not necessarily compel tightening on its own, the ECB may nevertheless choose to act even under such a scenario to protect credibility if the persistence risks linger. ECB President Christine Lagarde said last month that policy makers were ready to raise rates even if an increase in euro area inflation were to prove temporary.
A 25bp “insurance hike” by the summer may fit such a playbook: cautious in size, but decisive in signal. This would be policy aimed less at today’s reality than at tomorrow’s regret—the cost of doing too little being judged higher than the cost of doing slightly too much—especially following the late response following the 2022 energy crisis. And crucially, such a bias to hike may hold even if a fragile US–Iran ceasefire hypothetically holds: the ECB would still be managing the aftershocks in expectations, not just the headlines.
Moderate rate increase(s) would target ensuring inflation expectations stay firmly anchored and trimming second-round effects, while restricting the damage to the economy and the labour market. At the same time, the ECB may shy from fulfilling present market expectations pricing three 25bp hikes before the year is out less elevated energy prices more meaningfully de-anchor expectations.
