- Monetary policy should not be based on oil prices alone
- ECB needs to assess whether the energy shock spreads to inflation expectations, wages and core inflation
- It’s worth preparing for a protracted conflict in the Strait of Hormuz
- If events turned out differently, it would be easier to adjust
- Key factors are the strength and duration of the energy shock and any broader pass-through into inflation
- The energy shock is not, at least so far, quite comparable to the 2022 shock
- The ECB is committed to keeping inflation stable around 2% over the medium term
- Full report here
ECB’s Rehn stated that the ECB should not base its monetary policy solely on fluctuating oil prices despite the uncertainty caused by conflict in the Middle East. Rehn noted that while the current situation presents a stagflationary shock, with slowing growth and higher inflation in the short term, it remains fundamentally different from the severe energy crisis of 2022. He cautioned against repeating the policy mistakes of 2011, where rate hikes in response to energy spikes were quickly reversed as the broader economy weakened.
Rehn emphasized that the central bank’s decisions will depend on whether higher energy costs translate into broader inflation through wages and long-term inflation expectations. While market-based inflation expectations remain anchored near the 2% target and wage data has been reassuring so far, the ECB is closely monitoring for any signs that this temporary price surge could become a persistent pressure.
Looking ahead to the ECB’s June meeting, Rehn indicated that policymakers will utilize updated projections and fresh data to assess the situation. He outlined three potential responses depending on the duration and severity of the shock, ranging from no action for temporary spikes to decisive tightening if inflation deviates significantly from the target. Ultimately, he stressed that the ECB is not committed to a specific rate path and will continue to make data-driven decisions on a meeting-by-meeting basis to ensure medium-term price stability.
The market is currently pricing in an 86% chance of a rate hike in June with a total of three hikes expected by year-end. But as noted by other ECB policymakers, everything hinges on the Strait of Hormuz. If we get a resolution before June and oil prices fall significantly, the ECB will likely hold off from hiking
