Instant View: ECB Holds Rates Steady as Middle East War Re-Ignites Inflation Fears

ECB holds rates steady as Middle East war re-ignites inflation fears

ECB Decision and Market Reactions

LONDON, March 19 (Reuters) - The European Central Bank kept its key interest rate at 2% on Thursday and warned that the war in Iran was clouding the outlook for growth and inflation in the euro zone.

Short-dated government bond yields, the most sensitive to rate expectations, remained sharply higher on the day with Italian yields up 11 basis points

The euro was up 0.25% at $1.1482, while European shares were down 2.5% as world markets came under renewed selling pressure on worries about the Middle East conflict.

Market Commentary

COMMENTS: 

Evelyne Gomez-Liechti, Multi-Asset Strategist Global Markets, Mizuho International in London

"For me, the sentence that is key is the fact that they said they are well positioned to navigate the uncertainty – that is a big hint, it means that they probably think 2% is a good deposit rate level, if long-term inflation expectations are well anchored, that's the main difference with the Bank of England’s long term inflation de-anchoring.  That’s what the market is reacting to and why we have lower yields after the statement release."

Jack Allen-Reynolds, Deputy Chief Euro-Zone Economist, Capital Economics, London

"The ECB’s press release and updated forecasts suggest that policymakers think that the inflationary effects of higher energy prices will outweigh the disinflationary effects of weaker economic growth. While they are not rushing to judgement, if energy prices remain at their current levels or rise further, we doubt that they would wait long before raising interest rates."

Marchel Alexandrovich, European Economist, Saltmarsh Economics, London

"The ECB leaves rates on hold, with the Governing Council “not pre-committing to a particular rate path.” However, core inflation is now forecast to average 2.1% in 2028 (versus 2.0% in December). So, despite a weaker GDP growth profile, inflation is expected to remain above target for an extended period of time, which suggests that some on the Governing Council may start discussing the need for tighter policy."

Richard Carter, Head of Fixed Interest Research, Quilter Cheviot, London

“Given the headroom available, you could conceivably see the ECB make a move to raise interest rates once or twice this year to pre-empt any inflationary spike as a result of a sustained rise in energy prices."

Balancing Inflation and Economic Growth

"What may be difficult is finding what is the most appropriate level of action given the sluggish economic growth still being experienced in Europe. Any inflation spike will naturally act as a brake on economic growth, so it is important the ECB does not overtighten and keeps focus on the economic outlook. This is of course very difficult with such a moving picture in the Middle East and thus the outlook for interest rates is very much up in the air from here.” 

Madison Faller, Global Investment Strategist, J.P. Morgan Private Bank, London

"Europe has more at stake in this energy shock, and the ECB knows it. That backdrop forced a meaningful shift in tone today. Inflation forecasts have been revised higher, growth forecasts trimmed, and a hiking bias is now being telegraphed. The ECB is not committing to a hike, but it is not pushing back on the aggressive flip in market expectations or ruling one out either."

Reporting and Compilation

(Reporting by the Reuters Markets Team; Compiled by Dhara Ranasinghe, Editing by Amanda Cooper)