ECB Set For Rate Hike As US-Iran War Pushes Inflation To 3.2%

The European Central Bank (ECB) is moving to hike interest rates on Thursday, June 11. It comes amid economic repercussions of the ongoing U.S.-Iran conflict that pushed euro zone inflation beyond the central bank’s target range.

Why Is The ECB Looking To Raise Interest Rates?

The markets are anticipating that the ECB will raise its main deposit rate by 25 basis points to 2.25%. If announced, it will be the bank’s first hike in nearly three years.

The expected rate hike would follow the currencies’ inflation rate surging from 2.6% in February to 3.2% in May. The surge is driven by the rise in energy costs associated with the US-Israel-Iran war in the Middle East.

Growth in the euro area remains weak but policymakers are increasingly concerned with avoiding that higher energy prices start to drive up overall inflation. A number of ECB officials had been calling for a tightening earlier this year. Moreover, concerns about inflation expectations looked like it has made the case for a quick tightening even stronger.

“The ECB needs to hike to protect credibility and prevent inflation expectations from de-anchoring, but it is still operating around neutral rather than moving decisively into restrictive territory,” said Annalisa Piazza at MFS Investment Management.

Investors are also looking for any clues as to the policy direction after Thursday’s meeting. Financial markets now reflect a minimum of two more rate hikes in the coming year. However, the bank’s officials aren’t expected to make a formal commitment to further rate hikes this week, per Reuters report.

The policy tightening could impact the Bitcoin and crypto market negatively as high borrowing rates often decrease liquidity for risk assets. Amid this hawkish stance, ECB has also recently flagged major risks associated with stablecoins for monetary policy.

What Do Experts Say?

The ECB’s new economic projections might further fuel hopes for more measures, said JPMorgan economist Greg Fuzesi. “New staff projections are likely to be consistent with three hikes and [ECB President] Lagarde is unlikely to dismiss this as unreasonable,” he said.

He said “That would give the meeting a clear hawkish feel, even if the communication is likely to be more consistent with the next move in September.”

Some experts label the upcoming raise as an “insurance hike” to curb the inflation risks to remain in check. Nevertheless, a few economists believe the ECB should take action at the wrong time, given the euro zone’s slowdown in labor markets and weak demand.

Berenberg economist Holger Schmieding cautioned the central bank was “heading for a policy mistake.” For this, he cited the surge in inflation is mainly increasing due to prices of fuel and energy instead of stronger domestic demand.

Meanwhile, ECB Chief Economist Philip Lane has said the shock to eurozone economies from Iran is likely to be wider in its impact than the surge in inflation from the Ukraine conflict. He believes the US-Israel-Iran war impacts on energy markets more directly owing to the closure of the Strait of Hormuz.

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