San Francisco Frontiers - ECB to hike rates as Mideast war pushes up inflation

The ECB has kept borrowing costs on hold for some time as eurozone price rises had been largely under control.

But the US-Israeli war against Iran and near total closure of the Strait of Hormuz has sharply pushed up global energy costs, feeding into higher inflation.

Consumer price rises in the 21 countries that use the euro accelerated to 3.2 percent in May, above the ECB's two-percent target.

Analysts expect the central bank's governing council to deliver a quarter percentage point increase to the key deposit rate, taking it from 2.00 to 2.25 percent, when it meets Thursday.

"Anything but a rate hike at the ECB meeting would be a big surprise," said ING economist Carsten Brzeski.

Higher borrowing costs tend to dampen demand, helping to bring down inflation.

Other major central banks, including the US Federal Reserve and the Bank of England, have so far kept rates on hold as they assess the fallout from the conflict.

Thursday's move would mark the first time the Frankfurt-based institution has increased rates since September 2023, as it battled a historic surge in inflation unleashed by Russia's invasion of Ukraine.

Following that, the central bank delivered a series of cuts as inflation eased, but has held rates steady since June last year.

- Laying the groundwork -

Several ECB officials have been laying the groundwork for an increase in borrowing costs in their public remarks.

Chief economist Philip Lane signalled in late May a hike is ahead, with comments that he expects the ECB's inflation forecasts to be raised again at Thursday's meeting.

"There are several factors related to the Iran war that show that the macroeconomic outlook has gotten worse," he told Japanese business daily Nikkei.

But some economists have criticised the expected hike as it could constrict growth further in the sluggish eurozone by making it more costly for households and businesses to borrow.

This comes with the war already adding to headwinds as the single currency area is heavily dependent on energy imports.

The European Union last month slashed its growth forecast for the eurozone to 0.9 percent for 2026, down from a previous prediction of 1.2 percent.

Revised data released Friday showed the eurozone economy contracted 0.2 percent in the first quarter.

- 'Providing reassurance' -

Chief economist at Allianz, Ludovic Subran, told AFP that raising borrowing costs would be a bid to "provide reassurance" that the ECB was keeping an eye on higher inflation.

But he added: "This hike is not necessary; the ECB could wait, especially since the slowdown in growth is clear."

ECB officials may however be nervous about waiting too long to act, especially after facing criticism for moving too slowly to tame the inflation surge in 2022.

Investors will be watching ECB President Christine Lagarde's post rate-decision press conference closely for any clues about the path forward, although she is expected to stay tight-lipped.

Most analysts stress the economic backdrop now is different to that in 2022; inflation was already elevated before the outbreak of the Ukraine war, and the global economy was struggling with post-pandemic supply chain woes.

Given that, they don't expect Thursday's move to herald the start of an aggressive rate-hiking cycle.

Jack Allen-Reynolds, deputy chief eurozone economist at Capital Economics, said he thought that the ECB would likely deliver another hike at its next meeting in July, but stop there.

The knock on-effects "of higher energy prices on inflation should be limited, meaning that the ECB's tightening cycle will be short," he said.

C.Williams--SFF