Bundesbank Chief Signals Hawkish Stance: ECB May Resume Rate Hikes in April if Middle East Conflict Drives Inflation Deterioration

The Wall Street Journal reports that Joachim Nagel, a member of the European Central Bank Governing Council and the President of the German Bundesbank, stated that if European price pressures further increase due to the Iran war, the ECB may need to consider restarting the rate hike process as early as next month’s monetary policy meeting. He said in a media interview on Friday, “Given the current situation, it is conceivable that the medium-term inflation outlook could worsen, and inflation expectations may continue to rise, which means we might need to adopt a more tightening monetary policy stance.”

While the ECB is assessing the impact of the Middle East conflict on inflation and the economy, it maintained its deposit facility rate at 2% for six consecutive meetings on Thursday, in line with market expectations. However, the ECB adopted a more hawkish tone regarding risks facing the eurozone.

In its Thursday monetary policy statement, the ECB said, “The Middle East conflict has increased uncertainty about the outlook, bringing upside risks to inflation and downside risks to economic growth.” “The conflict will have a material impact on short-term inflation through higher energy prices. The medium-term impact will depend on the intensity and duration of the conflict, as well as how energy prices transmit to consumer prices and the overall economy.”

The German Bundesbank President added, “We expect to receive more reliable data before the ECB Governing Council’s next meeting in about six weeks.” Nagel repeatedly referenced the previous surge in prices driven by Russia’s invasion of Ukraine in 2022, calling this experience “highly relevant in the current context” — even though the ECB is now “in a better policy starting position.”

These comments highlight growing concerns: a new wave of geopolitical conflict in the Middle East triggering a surge in energy prices, threatening to push inflation higher while hampering economic growth.

EU leaders held a summit in Brussels on Thursday, with ECB President Christine Lagarde attending. Leaders are preparing for a potentially prolonged energy supply crunch, following recent Israeli bombings of Iran’s critical gas fields, which have severely damaged a major natural gas infrastructure project developed in cooperation with Qatar and ExxonMobil.

“If production capacity itself is destroyed, the impact of this war will be more lasting,” French President Emmanuel Macron said.

Despite the ECB maintaining rates for six consecutive meetings this week, sources say that if spillover effects from the war push inflation well above the ECB’s long-term target, policymakers are prepared to raise borrowing costs as early as April 30. The markets are betting on three rate hikes of 25 basis points each this year, with the first possibly as soon as April.

The latest ECB forecast summary shows that the eurozone consumer price index will rise by 2.6% this year, well above previous baseline expectations. The bank also stated that in an extreme scenario where oil and natural gas supplies are disrupted until the end of 2026, inflation could peak at 6.3% in the first quarter of 2027.

The chart above shows the latest ECB inflation and economic growth forecasts.

Nevertheless, ECB President Lagarde remains firm, asserting that she and her colleagues “are well-positioned and equipped with sufficient tools to respond to the unfolding significant energy price shocks.” She emphasized their commitment to keeping inflation anchored at 2% long-term.

Just hours before this monetary policy meeting, the geopolitical conflict in the Middle East further escalated, with Iran’s missile strikes damaging the world’s largest liquefied natural gas export facility in Qatar, an attack that may take years to repair.

Such unpredictable geopolitical developments place policymakers in a dilemma: they have stated they will not allow a repeat of the record-breaking inflation surges of 2022 and 2023 and have promised decisive action. However, higher energy costs could also undermine the region’s fragile long-term economic recovery.

Nagel stressed that Thursday’s decision “was appropriate,” repeatedly emphasizing energy-driven price issues in the interview and describing the current situation as “challenging.”

“He said further developments in geopolitical conflicts will have a significant impact on medium-term inflation,” and added that future ECB monetary policy decisions “will depend on this.”

He emphasized that ECB rate setters “will maintain a cautious monetary policy stance and act with the necessary resolve.” “Our primary goal is price stability. Everyone will benefit from it,” he said.

The Federal Reserve kept its benchmark interest rate unchanged on Wednesday as markets expected, but Fed Chair Jerome Powell signaled a hawkish stance at the press conference, emphasizing that oil price shocks make the inflation outlook too uncertain to commit to easing. Powell repeatedly stressed that the Fed is unlikely to cut rates again before inflation shows clear signs of cooling, even as it has not yet factored in the potential inflationary impact of the Middle East war, stating it is too early to judge the war’s effects.

On Friday, global stock and bond markets declined in unison, with the three major US stock indices suffering sharp losses. Gold, traditionally the safest asset, is heading toward its worst week since 1983. Bond traders on Friday even priced in a 50/50 chance that the Fed might hike rates instead of cutting in the second half of the year, while the S&P 500 extended its longest weekly losing streak in a year. In contrast, last month, bond markets priced in 2-3 rate cuts by the Fed and even anticipated a potential restart of rate cuts as early as June.

Compared to the US, which is rich in oil and gas resources, Europe, heavily dependent on energy imports, faces more pronounced energy-driven inflation pressures. The ECB and the Bank of England are both confronting similar tough issues — with energy-driven inflation severely hampering rate cuts, even as economic growth prospects worsen, forcing them to hold steady or even consider rate hikes starting from April. Market futures and currency markets have already priced in a 75% probability that the ECB will start its first rate hike as early as April, with nearly three 25 basis point hikes fully priced in for this year.