The European Central Bank (ECB) has warned that heightened geopolitical tensions in the Middle East could push energy prices and freight costs higher in the near term, changing the inflation outlook and the trajectory for interest rates.
In its latest economic bulletin, published in the wake of its January meeting in which it kept interest rates unchanged, the bank said interest rates would remain at “sufficiently restrictive levels for as long as necessary”.
While predicting inflation would ease further over the course of 2024 “as the effects of past energy shocks, supply bottlenecks and the post-pandemic reopening of the economy fade, and tighter monetary policy continues to weigh on demand”, the bank warned there were a number of upside risks to the inflation outlook.
They included heightened geopolitical tensions, especially in the Middle East, with attacks on tankers in the Red Sea intensifying, which had the potential to push up energy prices and freight costs as well as hampering global trade.
“Inflation could also turn out higher than anticipated if wages increase by more than expected or [company] profit margins prove more resilient,” it said.
Conversely, inflation could surprise on the downside if monetary policy dampens demand by more than expected, or if the economic environment in the rest of the world worsens unexpectedly, it said.
Expectations that Frankfurt would start cutting interest rates in April have dimmed after euro zone inflation eased less than anticipated at the start of the year.
After a pickup in December, driven by base effects, consumer prices rose 2.8 per cent from a year ago in January, according to provisional Eurostat figures. That was above the 2.7 per cent estimate predicted by economists.
After 10 consecutive rate hikes between July 2022 and September 2023, the ECB has hinted at a possible loosening of monetary policy later this year. Officials are, however, wary of providing clear guidance on timing until they are sure price growth is firmly on its way back to the ECB’s 2 per cent target.
ECB president Christine Lagarde said last month that Frankfurt wants to be “further along the disinflation process to be sufficiently confident”. She signalled that a move before June’s meeting was unlikely, noting that wage data due just before that meeting would be “critically important”.
Policymakers are concerned that while headline inflation is falling, price growth in the services sector, underpinned by wage growth, is proving stickier than expected.
In its latest bulletin, the ECB noted that the euro area economy was likely to have stagnated in the final quarter of 2023 and that “the incoming data continue to signal weakness in the near term”.
It also warned that the risks to growth “remain tilted to the downside”.
The bank said growth could be lower if the effects of monetary policy turn out stronger than expected. It also highlighted “Russia’s unjustified war against Ukraine and the tragic conflict in the Middle East” as key sources of geopolitical risk.
“This may result in firms and households becoming less confident about the future and global trade being disrupted,” it said. Conversely, it said growth could be higher if rising real incomes mean spending increases by more than anticipated.
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