ECB Governors Signal Vigilance Over Inflation as Banks Bet on Rate Hikes

ECB Policymakers Signal Vigilance While Banks Bet on Upcoming Rate Hikes

ECB Policy Stance and Market Reactions

ECB Policymakers Express Caution Amid Inflation Risks

FRANKFURT, March 20 (Reuters) - European Central Bank policymakers warned of growing inflation risks on Friday, but stopped short of calling for tighter policy, even as a host of brokerages started pencilling in rate hikes from as soon as April.

The ECB left interest rates unchanged on Thursday but warned that the U.S.-Israeli war in Iran could push inflation far above its 2% target this year and a lengthy conflict could keep price growth elevated for years to come. 

This view bolstered already widespread rate hike bets and policymakers, speaking on condition of anonymity, did acknowledge that April might be in play unless the conflict is resolved in the coming weeks. 

Their public commentary on Friday was more measured, however.

Central Bank Governors Urge Prudence

"We must keep a cool head and keep our eyes on the entire playing field," Finnish central bank Governor Olli Rehn said, adding that policymakers need to separate short-term volatility from the longer-term economic impact.

French Governor Francois Villeroy de Galhau said the ECB must not overreact to the energy price surge, which could push inflation to 2.6% this year, according to the ECB's baseline projection. 

"We have the eyes on the ball and the hands ready to act," he said in an interview with Financial News website Boursorama.

Bank of Spain Governor Jose Luis Escriva meanwhile warned that it remains difficult to assess the impact of higher energy prices on the trajectory of inflation, so the ECB should stick to its practice of making decisions meeting by meeting.

Markets and Analysts Anticipate Rate Hikes

Market Expectations for Rate Increases

MARKETS BETTING ON RATE HIKES FROM JUNE

Financial markets now see more than two rate hikes this year, with the first one coming in June. Central banks normally look past oil shocks but the fear is that the energy-price surge is so large, it will seep into the broader economy, impacting the price of everything and lingering for an extended period.

Bundesbank President Joachim Nagel acknowledged this risk and said the ECB might be forced to step in, unless energy prices normalise soon.

"As things currently stand, it is conceivable that the medium-term inflation outlook could deteriorate and inflation expectations could rise on a sustained basis, meaning that a more restrictive monetary policy stance would probably be necessary," Nagel told Bloomberg.

Brokerages Revise Forecasts

Brokerages meanwhile started betting on quick rate hikes, changing their calls in the wake of Thursday's ECB meeting.

J.P. Morgan, Morgan Stanley and Barclays now all expect the ECB to hike rates in 2026, a sharp shift from their previous forecasts for rates to remain on hold.

Barclays and J.P. Morgan see a move in April, followed by further increases in June and July, respectively. Meanwhile Morgan Stanley expects 25-basis-point hikes each in June and September.

Not All Economists Are Convinced

Still, not everyone was convinced.

"The ECB Governing Council is dominated by members who have a dovish bias," Commerzbank chief economist Joerg Kraemer said.

"I remain unconvinced by the futures markets’ expectation that the ECB will raise its key interest rates a good two times by the end of the year," he said. "The hurdle for higher key interest rates is higher than expected." 

(Reporting by Balazs Koranyi, Francesco Canepa, Jesús Aguado, Makini Brice, Gianluca Lo Nostro and Inti Landauro; Editing by Sharon Singleton)