The European Central Bank (ECB) is facing growing pressure to tighten monetary policy as the conflict in the Middle East pushes up energy costs and raises concerns that inflation across the euro zone could remain stubbornly high.
Money markets are increasingly betting that the ECB will raise its deposit rate to 2.5% in September, following a rate increase in June aimed at containing price pressures linked to the energy shock caused by the U.S.-Iran war.
Investors are also pricing in a growing possibility of further rate increases. Markets currently see roughly a 25% chance of the ECB deposit rate reaching 3% by March 2027, rising to about 60% by September 2027. A month earlier, traders had seen virtually no chance of rates reaching that level by March.
The outlook has been shaped by oil prices, which remain above $90 a barrel, as well as concerns about tighter supplies of refined fuels and low natural gas inventories across the euro zone. Analysts say the conflict could continue to affect energy markets well beyond the coming months.
The Strait of Hormuz remains a major concern because the waterway normally handles about one-fifth of global oil and liquefied natural gas exports. Any prolonged disruption could keep energy prices elevated and add to inflationary pressure on European households and businesses.
Refined fuel markets are also under pressure. Analysts say crack spreads, which measure the margin between crude oil and refined products such as diesel, remain elevated, suggesting that fuel costs could stay high even if crude oil prices retreat.
European natural gas supplies are another concern. Euro zone gas storage levels are at their lowest for this time of year in more than a decade, raising concerns about the region’s ability to rebuild reserves before winter. Hot weather has also increased demand for electricity used for cooling.
At the same time, some of the forces that previously helped bring inflation down are beginning to fade. Expansionary fiscal policies, increased defence spending, green-transition investment and tight labour markets could keep underlying price pressures elevated.
The euro zone economy has also shown signs of resilience. Business activity expanded at its fastest pace of the year in August, suggesting that the economy may be strong enough to withstand tighter monetary policy.
The ECB’s challenge is therefore becoming more complicated. While higher interest rates could help contain inflation, excessive tightening could weaken economic growth and consumer spending.
Economists say the future path of monetary policy will depend heavily on how long the Middle East conflict lasts and whether energy prices remain elevated.
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