Price pressures are broadening – the ECB must act now
Lena Dräger, Research Director of the Monetary Macroeconomics group at the Kiel Institute for the World Economy, comments on the expected decision of the European Central Bank (ECB) to raise its policy interest rate:
“The ECB is likely to raise the deposit facility rate by 25 basis points to 2.25 percent at its meeting on 11 June 2026—and this step is now appropriate. According to Eurostat’s flash estimate, headline inflation in the euro area rose to 3.2 percent in May, the highest level since September 2023. While the energy component, at 10.9 percent, still makes the largest contribution, price pressures have now broadened beyond the energy sector. Core inflation excluding energy and food climbed from 2.2 to 2.5 percent, and services prices from 3.0 to 3.5 percent. It is precisely this development that is decisive: a shift away from a purely external supply shock towards broad-based price pressure.
The cause remains on the supply side, as the blockade of the Strait of Hormuz in the wake of the war in Iran continues to keep oil prices elevated. Monetary policy cannot directly counter such a supply shock. Thus, the ECB must watch all the more closely how this pressure is now spilling over into services prices and feeding into households’ inflation expectations. According to the ECB’s Consumer Expectations Survey (April wave, published on 1 June), consumers expect an inflation rate of 4.0 percent over the next twelve months, which is twice the target. Longer-term expectations, at 2.9 percent three years ahead and 2.4 percent five years ahead, are better anchored but likewise sit above the target.
A rate hike will not lower the price of oil; rather, it serves to preserve the ECB’s credibility in the fight against inflation and to stabilize expectations before the shock becomes entrenched. The fresh memory of the 2022 inflation wave raises the risk of second-round effects, even if wage growth has so far remained moderate. Moreover, unlike during the last surge in inflation, the ECB is now free of institutional constraints such as the pre-announced net asset purchases under its Asset Purchase Programme and can act decisively. For now, however, only a single rate step should be taken, not a pre-committed series. The euro area remains mired in a stagflationary economic environment, with weak growth and recession risks in Germany. Overly aggressive monetary tightening would choke off the fragile economy without being able to address the energy price shock directly. The right response is therefore to act now, but with a clear and data-dependent reaction function. ECB President Christine Lagarde should keep the door open for further steps should price pressures become entrenched, while at the same time signaling flexibility should energy price pressures ease.”
