Summary
Renewed fighting between the U.S. and Iran has caused energy prices to climb again, undermining recent easing in inflation pressure and complicating the ECB's policy outlook, according to Yannis Stournaras. The Greek central bank governor said the situation in the Middle East is once again precarious and volatile, increasing uncertainty around inflation forecasts and creating fresh challenges for monetary policy.
Background and recent moves
The European Central Bank increased interest rates at its June 10-11 meeting. At that time, a subsequent retreat in energy prices following a ceasefire had reduced immediate pressure on the bank to act again at its next meeting scheduled for July 22-23. Despite that temporary reprieve, the case for additional tightening later remained solid, according to four sources cited last week.
What changed
Stournaras said hostilities have resumed, prompting renewed upward pressure on energy costs. He told an event in Greece: "Hostilities started again. So we’re back to square one and that shows how precarious and volatile is the situation in the Middle East and, as a consequence, it also shows the uncertainty surrounding inflation forecasts and therefore the challenges that policy has to face."
Market participants had briefly scaled back expectations for another immediate ECB hike after the ceasefire-driven drop in energy prices, but in recent days traders have increased their bets on further ECB tightening as indications emerged that the deal to end hostilities could be at risk.
Implications for policy and markets
The renewed volatility in energy markets has reintroduced an important input to inflation forecasting in the euro zone. Policymakers face heightened uncertainty when assessing whether inflation will remain on a disinflationary path or be pushed higher by rising fuel costs. Investors currently expect the ECB to raise rates two more times over the next year to help contain the inflationary fallout from the renewed Iran-related conflict on energy prices.
Conclusion
Renewed hostilities between the U.S. and Iran have reversed some of the recent easing in energy-driven inflation pressure, placing the ECB back at an earlier decision point. That dynamic increases uncertainty for inflation forecasts and complicates the timing and scale of future monetary policy actions.