ECB caught between oil price shock and slowing growth
Lena Dräger, Research Director of the Monetary Macroeconomics Group at the Kiel Institute for the World Economy, comments on the European Central Bank’s (ECB) expected decision to keep the policy rate unchanged today:
“At its meeting today, the ECB is likely to keep the deposit rate at 2.0 percent—and that is the right move at this time. The oil price shock triggered by the war in Iran drove headline inflation in the euro area to 2.6 percent in March, with the energy component jumping from minus 3.1 to plus 5.1 percent. At the same time, the shock has severely dampened economic activity: The ECB has revised its growth forecast for the eurozone down to 0.9 percent, and Germany faces the threat of recession. The eurozone thus finds itself in a classic stagflationary situation, leaving little room for maneuver in monetary policy. Core inflation has remained stable at 2.3 percent so far, suggesting that this is still an external supply shock rather than a broad-based acceleration of price pressures.
However, delayed price effects loom, which could keep inflation elevated longer than currently expected. Higher energy costs typically feed through to food prices with a lag of one to two quarters—via increased transportation, storage, and processing costs. In addition, fertilizer prices are rising significantly, as over 30 percent of the world’s traded urea is transported through the Strait of Hormuz. These indirect effects increase the risk that inflation will remain above the target more stubbornly.
The experience from the 2022 energy shock serves as a warning to remain vigilant: At that time, the ECB was relatively late in hiking interest rate, partly because it first had to scale back net bond purchases under the Asset Purchase Program (APP). Today, these institutional constraints no longer exist—the ECB can react more quickly and flexibly. Given the stagflationary environment, a preventive interest rate hike would nevertheless be misguided at this point: It would place an additional burden on the already weak economy without being able to directly combat the energy price shock. The right response is: wait and see, but with a clear reaction path. The ECB must send an unambiguous signal that, should inflationary pressures intensify, it will act swiftly and decisively this time.”
