MNI SOURCES: ECB's Ukraine Lesson Lowers Oil Shock Tolerance

The European Central Bank would have lower tolerance for any extended energy price shock resulting from the Iran war than in the past, with the lesson of the steepening of inflation expectations in the aftermath of Covid and Russia's invasion of Ukraine fresh in policymakers’ minds.

While there is little doubt that the ECB will initially look through the energy price spike, which cannot be directly remedied via interest rates, officials pointed out that the central bank’s description of its current policy stance as being in a “good place” allows quick action in either direction. They noted that if the U.S.-Israeli attack on Iran eventually prompts the ECB to act, this will not necessary be in the form of a hike.

“There are so many variables and so many possibilities, it is unwise to point to any likely direction of action down the line,” one source said.

“If the situation does deteriorate, and the economy slows and confidence slumps, we may not be in a position to raise rates  -- but those hypotheticals are some way off yet”, another official noted.

One official said the Governing Council is likely to remain in a holding pattern with the deposit rate at 2% for some time, though hawks will push for a shorter tolerance period than in response to the 2022 inflationary surge. Another source said the effect of higher oil prices will be considered in the ECB’s March projections, but that the situation could change quickly. (See MNI INTERVIEW: ECB Rates Move Needs Clear Trend Change-Demarco)

“It is difficult to say what ‘temporary’ might mean in practice. The conflict between Russia and Ukraine shows that some geopolitical tensions can turn out to be prolonged”, another official said, warning that the ECB could soon have to revise its medium-term inflation projections above its 2% target.

SECONDARY IMPACT

“There will be closer attention to the secondary impact and it is very unlikely that the Governing Council will allow the impact to be an issue without greater consideration for as long as after the Ukraine invasion,” one official from a national central bank said.

Even a short-lived rise in energy prices would could push inflation expectations higher, officials said, pointing to research which implies that an inflation wave which closes follows an early price surge is likely to have stronger effects. But they also pointed to the effect on confidence and activity of higher energy costs.

 “What we need to monitor carefully are perceptions - and that is two-sided. We must monitor inflation expectations and confidence indicators, as they will offer some look at the wider picture,” one said. (See INTERVIEW: Eurozone Risks Tilt To Downside - ECB's Stournaras)

“Historically, 10 dollars of oil used to equate to 0.1 to 0.15 percentage points of headline inflation, starting to impact year-on-year readings after four to six months. Whether that is still a direct correlation, I'm not sure. And perhaps the gas price correlation will be more important.”

An ECB spokesperson declined to comment.