European Central Bank (ECB) efforts to project calm over war and inflation are being tested as markets price in a hike in interest rates this year.
Traders who until recently expected borrowing costs to stay at 2% into 2027 now see surging energy costs as a potential threat to prices in Europe — and one that could force the ECB’s hand.
In public, officials portray a steady-as-it-goes approach to interest rates. Privately, however, policymakers speaking on condition of anonymity are alert to the risks and keen to stay nimble — even if rapid action is unlikely.
The challenge is to acknowledge mounting dangers stemming from President Donald Trump’s military campaign in Iran without fueling a further tightening in financial conditions.
The situation recalls 2022, when Russia’s invasion of Ukraine sent inflation soaring and the ECB defied market expectations for higher borrowing costs before belatedly yielding.
That’s a comparison that officials like Bank of France Governor Francois Villeroy de Galhau and his Dutch counterpart Olaf Sleijpen would rather avoid, with the latter insisting the circumstances are “different” now.
“The ECB is clearly looking at it, but won’t necessarily react, while markets try to front-run developments,” Spyros Andreopoulos at Thin Ice Macroeconomics said. “The situation is in flux and policymakers themselves try to see what’s appropriate next.”
The change in rate wagers is taking place in tandem with a global shift in perceptions of the risks to monetary policy — one that’s reduced expectations of a cut by the Bank of England in 2026 and helped drive fluctuating bets this week for the Federal Reserve.
The 2022 episode remains sensitive inside the ECB, reinforcing criticism that its consensus-driven, process-heavy set-up can slow decision-making. It added to a narrative of earlier missteps, including rate increases in 2008 and 2011 that were later reversed.
Chief Economist Philip Lane, the cheerleader for the central bank’s low-rate policy in 2021 and early 2022, subsequently found himself defending that record. He even appeared to cite the prior hiking mistakes when doing so.
“The post-hoc thing — ‘well we’ve seen inflation therefore I conclude you were too slow in hiking’ — I’d like to counterbalance that with all those episodes in history where maybe some central banks hiked too quickly, and what happened then,” he told detractors in March 2023. Later that year, he insisted the delay in raising rates didn’t make a “massive difference.”
Earlier this week, when asked by the Financial Times whether the ECB is scarred by the inflation crisis a few years ago, Lane immediately replied that officials “carry two scars,” with the “chronic, below-target inflation before the pandemic” being the second. “That is still in the memory bank,” he said.
Sleijpen, similarly, declared that the ECB is “clearly not in the same situation.”
“The nature of the shock is different,” he said, adding that “monetary policy is in a neutral setting now, which wasn’t the case back then.”
On Thursday, Bundesbank President Joachim Nagel also highlighted differences, arguing that back then, large-scale asset purchases were still in place — in addition to an even negative deposit rate.
Ultra-loose policy settings in 2022 at a time of already high inflation informed the narrative of critics at the time. “It’s extraordinary that this should have been allowed,” former Bank of England official Charles Goodhart said in May of that year, shortly before the ECB pivoted toward hiking.
Nagel’s remarks, however, suggest the ECB may respond more swiftly time around if energy-supply disruptions caused by events in the Middle East meaningfully increase inflation, and with it, consumer expectations. He stressed the institution’s full commitment to ensuring price stability.
“We can and will do everything necessary to achieve this goal,” Nagel said.
Ultimately, for central banks, it isn’t just the magnitude of the shock that matters, but its persistence. How long the disruption lasts — and whether higher prices spill over into wages and inflation expectations — will determine the risk of second-round effects.
What’s already happened with the repricing of rate bets is a significant tightening of financial conditions, according to Andreopoulos, a former ECB economist.
That in itself will leave officials with food for thought in the coming weeks. A quiet period before their March 19 decision will kick off next Thursday.
Before that, markets will be on the lookout for hints that the ECB’s stance is shifting. A call on Friday for “vigilance” by hawkish Executive Board member Isabel Schnabel may even have stirred memories of former ECB President Jean-Claude Trichet’s signaling of an imminent rate hike.
For all the painful flashbacks to the energy shock after the invasion of Ukraine, however, the central bank will need to stay sanguine for now, said Simona delle Chiaie, Bloomberg’s chief euro-area economist.
“The greater risk may be leaning too much on the lessons of 2022 — allowing the memory of that shock to shape policy expectations before the data justify it,” she said.
