The European Central Bank (ECB) President Christine Lagarde announced on Wednesday that the ECB is prepared to hike interest rates even if the anticipated surge in euro zone inflation proves to be short-lived, following the outbreak of war in Iran which has disrupted inflation forecasts [1]. The ECB maintained its key deposit rate at 2% during its last monetary policy meeting, but has upgraded its inflation outlook, now expecting headline inflation to average 2.6% in 2026, 2% in 2027, and 2.1% in 2028 in its baseline scenario [1].
Lagarde emphasized that even a "not-too-persistent" overshoot of the ECB's 2% inflation target could warrant a measured policy adjustment, warning that failing to address such an overshoot could create communication risks with the public [1]. She did not specify a timeline or criteria for when a rate hike might occur. The central bank's adverse scenario projects inflation peaking at 4% in 2026, while its most severe scenario—assuming a stronger and more persistent energy price shock and further destruction of Gulf energy infrastructure—foresees inflation peaking above 6% early next year [1].
The recent conflict in Iran, particularly Tehran's near-total blockade of the Strait of Hormuz, has caused global oil and gas prices to soar, significantly impacting inflation forecasts across Europe [1]. Prior to the conflict, euro zone inflation had dipped below the ECB's 2% target, reaching 1.9% in February, but the situation has since reversed [1].
ECB Chief Economist Philip Lane stated that the central bank will closely monitor companies' price-hike expectations and wages for new hires as key inflation indicators [1]. Additionally, there are signs that the Iran war is negatively affecting business confidence and activity, with private sector output in the euro zone's manufacturing and services sectors dropping to a 10-month low in March, according to S&P Global flash purchasing managers' index data [1].
CONCLUSION
The ECB is signaling a proactive stance on interest rate hikes in response to inflationary pressures stemming from the Iran conflict and energy price shocks. With inflation forecasts revised upward and business confidence declining, the central bank is closely monitoring key indicators and stands ready to act if inflation deviates significantly from its target. This approach suggests heightened vigilance and potential policy tightening ahead, impacting euro zone markets.