ECB policymakers warn prolonged Iran war could lift inflation, hit growth

Three European Central Bank policymakers warned on Thursday that euro zone inflation would likely rise, and growth sag, if the war in Iran were to become drawn out and suck in more countries.

 

As the US-Iran war entered its sixth day, the conflict has widened beyond Gulf states and into Asia, convulsing global markets and raising questions about the ECB's benign outlook for the euro zone.

 

The ECB's vice president Luis de Guindos and the central bank governors of Germany and Finland all said it was too early to draw conclusions but warned that a prolonged, wider war may push up inflation, both present and expected.

 

 

"The baseline (is) that this is going to be short-lived," de Guindos told an event in Brussels. "If it is longer, then there is a risk that inflation expectations will change." Inflation in the euro zone has been hovering around the ECB's 2% target, on par with the ECB's own policy rate.

 

But accounts of the central bank's last meeting published on Thursday showed policymakers were already worrying about geopolitical uncertainty in countries including Iran.

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The ECB was stung by an energy-led rise in inflation following Russia's invasion of Ukraine in 2022, which it initially wrote off as temporary before hastily raising rates by a record amount.

 

This was likely to make some policymakers more cautious this time around.

 

"I don't think we should be overly optimistic (about a swift resolution of the conflict)," Finnish governor Olli Rehn said at the same event, noting there had already been "quite some escalation".

 

Bundesbank president Joachim Nagel said the situation now was "somewhat different", noting monetary policy had been much looser in 2022, slowing down the ECB's reaction.

 

Like Rehn and several other policymakers who spoke in recent days, Nagel said a prolonged conflict in the Middle East would push up inflation and depress growth.

 

"If the conflict comes to a swift end...the consequences for inflation would be short-term and limited overall," Nagel said in a speech.

 

"By contrast, if energy prices were to remain elevated for an extended period of time, this would tend to lead to higher inflation and weaker economic activity in the euro area." This would be a tricky constellation for central bankers as brisker price growth would call for higher rates but sluggish growth would require the opposite.

 

Latvian central bank governor Martins Kazaks told Reuters earlier this week it would all depend on which of those two forces prevail and his Greek peer Yannis Stournaras called for flexibility in setting rates.

 

The ECB's next policy meeting is on March 18-19, with no change in interest rates expected.