The better news from the Middle East and the consequent fall in the price of oil ( Brent Crude is a further US $4 dollar this morning) will have the ECB with rather itchy shirt collars this morning. That is because on Thursday they announced this.
The Governing Council is committed to setting monetary policy to ensure that inflation stabilises at our two per cent target in the medium term. In line with this commitment, we today decided to raise the three key ECB interest rates by 25 basis points.
So the new interest is 2.25% as they mull the consequences of dithering and then setting out Forward Guidance, although it is not called that anymore after past debacles, for a rise in interest-rates. Such a long response function comes with risks.
The rationale was inflation although that was not entirely clear from their forecast.
In the baseline of the new Eurosystem staff projections, headline inflation is expected to average 3.0 per cent in 2026, 2.3 per cent in 2027 and 2.0 per cent in 2028.
As nothing can be done about 2026 now the rise relied on inflation supposedly being 0.3% above target next year as in 2028 it is back on target. So they would have pointed to core inflation as at least it is forecast to be 2.5%.
For inflation excluding energy and food, the baseline foresees an average of 2.5 per cent in 2026 and 2027 and 2.2 per cent in 2028.
They got there in the end with a more general statement.
Compared with March, staff have revised up their baseline projection for inflation in 2026 and 2027 owing to a higher path for energy prices, which, to some extent, is expected to feed into food, goods and services inflation.
Economic growth
This bit was rather awkward. We start with the long-running issue of weak economic growth.
The baseline sees economic growth at an average of 0.8 per cent in 2026, 1.2 per cent in 2027 and 1.5 per cent in 2028.
Back on February 19th I looked at the words of Dr, Isabel Schnabel admitting the long-running problem which had become so obvious the Euro area elite could no longer turn a blind eye to it. But the catch comes here.
This is a downward revision for 2026 and 2027, reflecting a more pronounced impact of the war on commodity markets, real incomes and confidence.
Whilst in isolation events in the Middle East have weakened economic growth for the Euro area there is always what used to be called a Black Swan event.
Also something really leapt off the page and the emphasis is mine.
Adjusting for a temporary factor in Ireland, the euro area economy grew in the first quarter, supported by domestic demand and exports.
After many years of looking away from this issue which boosted claimed Euro area growth we see that all that it took for a confession was a large fall! On a quarterly basis GDP in Ireland plunged leading to a situation described by the Central Bank of Ireland like this.
Despite the GDP decline of 12.1 per cent in Q1 2026, MDD rose in the quarter by 0.6 per cent. For the euro area, total GDP contracted by 0.2 per cent including the Irish GDP data. Using MDD for Ireland instead, euro area GDP rose by 0.2 per cent in Q1.
As you can see the usual metric would lead to fears of a Euro area recession so just like with inflation when reality is inconvenient they look for a new metric. If they were consistent an ex-Ireland measure would be an improvement as the Irish tail wages the European dog far too often due to its vulnerability which in this instance was pharmaceuticals and contract manufacturing.
Lagarde will be Lagarde
Here she is in the press conference.
Our reaction function has been very steady, repeated over the course of time,
Back in the cost of living crisis she told us that “inflation is a hump” and that she would not be raising interest-rates before a series of interest-rate hikes.
What happens next?
ECB President Lagarde has been interviewed on French radio this morning.
European Central Bank President Christine Lagarde said high energy prices are starting to feed through to other parts of the economy, according to an interview with France Culture.
“Indirect effects of inflation, we have absolutely started to see that more or less everywhere in recent weeks,” she told the French station on Monday. ( Bloomberg )
That is true albeit exactly the opposite reaction function to 2021 and early 2022.
The head of the German Bundesbank has also been speaking.
While the US-Iran agreement has improved market sentiment and raised expectations that shipping through the Strait of Hormuz could gradually normalize, Nagel warned that the inflationary damage from the disruption may have already extended well beyond the initial supply shock.
Nagel emphasized that the “ECB is no longer dealing with a short-term supply shock”. That statement suggests the ECB is worried that the energy shock transitioned into a broader macroeconomic problem, one with the potential to influence wages, services pricing, and inflation expectations. (investinglive)
It was a type of old-style Bundesbank speech.
ECB’s Nagel delivered a more hawkish message signalling that a rate hike in July cannot be ruled out due to inflation risks despite the US-Iran deal.
Although back in the day the Bundesbank would have raised interest-rates much more quickly. Also there was a bit which was rather awkward for the claim from Christine Lagarde that there had been no discussion of the neutral interest-rate.
Nagel also pushed back against the idea that current monetary policy is already restrictive enough to guarantee disinflation. He said that the “ECB policy settings are still broadly neutral”.
He is not alone in suggesting that it is not a case of one and done.
Peter Kazimir, a member of the European Central Bank’s (ECB) Governing Council and Governor of the Central Bank of Slovakia, said the ECB had taken the first step to contain price pressures, but it was becoming increasingly clear that more needed to be done. (ekoturk.com)
Comment
Whilst a case of really bad timing a 0.25% interest-rate hike is not that big a deal. Although of course it comes from a group of people who claim that it is! As to the next move we have a Genesis style land of confusion.
*ECB GOVERNORS EYE JULY PAUSE AFTER FIRST HIKE *ECB OFFICIALS SEE NEXT RATE HIKE POSSIBLE AS SOON AS JULY. ( @fwred)
So the regular burst of “sauces” has several flavours. In terms of bond markets after the interest-rate cuts leading to bond yield rises we now have an interest-rate rise seeing the German ten-year yield decline from 3.05% to 2.95%. It is not going to be easy for economic historians and econometricians to pick the bones out of that.
Meanwhile there is a shark in the water.
The digital euro breaks that circle. Because of its legal tender status, it must be accepted everywhere. (Christine Lagarde)