Market volatility can amplify shocks to euro zone economy, ECB's VP warns

ECB policymakers acknowledge war risk, promise to keep inflation in check

ECB Response to Surging Oil Prices and Inflation Concerns

FRANKFURT, March 11 (Reuters) - European Central Bank policymakers acknowledged on Wednesday the economic risk from surging oil prices and promised swift action if they thought higher inflation was at risk of getting entrenched.

ECB Policymakers Urge Caution Amid Rising Energy Costs

Speaking on their final day before going into a quiet period ahead of a March 19 policy meeting, they also played down the need for immediate action, calling for cool-headed analysis and time to see where energy costs settle.

Oil prices are up nearly 50% since the start of the year on the fallout from the Iran war and financial markets are betting the ECB will be less tolerant than in the past with higher inflation.

Vigilance and Potential ECB Action

"We must be very vigilant," Bundesbank President Joachim Nagel told Reuters.

"If it becomes apparent that the current energy price increases will translate into broad consumer price inflation in the medium term ... the ECB will act decisively."

ECB Ready but No Immediate Action Planned

ECB READY BUT NO NEED TO ACT JUST YET

Nagel's French counterpart, Francois Villeroy de Galhau, had a similar message, while acknowledging that the euro zone is now facing higher inflation and lower growth due to the war.

"We will not allow inflation to take hold, we owe this vigilance," he told French radio station RTL.

"I do not believe, as things stand today, that interest rates need to be raised right now," he added.

Market Expectations and Inflation Trends

Financial markets now see 30 to 35 basis points of rate hikes this year, a big shift compared to two weeks ago, when no change was expected for the entire year.

Imminent action is unlikely, however, as inflation was running below the ECB's 2% target in the early months of the year and past projections saw modest undershooting, suggesting some buffer for the ECB.

Challenges in Forecasting and Scenario Planning

Luis de Guindos, the ECB's vice president, however, acknowledged that financial market volatility can amplify shocks to the economy, making it exceptionally difficult to forecast either growth or inflation.

This is why the ECB is likely to look at several scenarios next week, much like it did two years ago when Russia attacked Ukraine, plunging Europe into an energy crisis, he told a conference in Madrid.

Estimating Inflation Impact

With energy prices moving rapidly, economists have struggled to estimate the inflation impact but some have said price growth could accelerate to as high as 2.5% this year.

The ECB generally looks past energy-induced inflation spikes as factors outside monetary policy's control.

Lessons from Past Energy Shocks

However, the experience of the 2021/2022 shock, when the bank's delayed response forced it to raise rates at a record pace when inflation reached double digits, could prompt it to act more quickly now, analysts say.

ECB Leadership Statements on Inflation Control

Like her colleagues, ECB President Christine Lagarde also acknowledged the uncertainty and promised the ECB will not let inflation take hold again.

"I can assure you ... that we will do everything necessary to keep inflation under control and to ensure that the French, the Europeans, do not experience inflationary increases like those we saw in 2022 and 2023," she said.

Potential for Future Policy Tightening

While no policymaker has called for a rate hike already next week, some have openly discussed the possibility of having to tighten policy eventually.

Peter Kazimir, one of the most outspoken policy hawks, said action may be closer than some expect.

"For the time being, we need to stay calm,” he told Bloomberg. “I’d say a reaction by the ECB is potentially closer than many people think.”

(Reporting by Balazs Koranyi, Francesco Canepa, Reinhard Becker, Jesus Aguado and Paolo LaudaniEditing by Tomasz Janowski)