Central banks edge toward rate hikes as energy shock revives inflation fears

European Central Bank policymakers are increasingly likely to raise interest rates at their June meeting, unless energy prices ease or the conflict involving Iran shows clear signs of ending. Although no final decision has been made, officials appear to be moving toward a more hawkish stance as renewed pressure in oil and gas markets threatens to push inflation higher across the euro area.

ECB President Christine Lagarde signaled that a rate increase will be seriously considered at the next meeting, after policymakers debated but ultimately rejected a hike this week. The deposit rate remains at 2%, but the central bank will receive updated economic projections in June, giving officials a clearer basis for deciding whether tighter policy is needed.

Lagarde emphasized that the coming weeks will be crucial for assessing the economy and inflation outlook. She noted that the euro area is moving away from the ECB’s previous baseline scenario, though she avoided saying whether conditions are approaching the more adverse scenario outlined earlier this year.

Inflation pressure collides with weak growth

The ECB faces a difficult policy dilemma. Headline inflation has risen to 3%, driven largely by higher energy costs linked to geopolitical tensions. At the same time, the euro-zone economy is showing signs of weakness, with first-quarter growth of only 0.1%. This combination has revived concerns about stagflation, even though Lagarde played down that risk.

So far, ECB officials have not seen strong evidence of second-round effects, such as higher wages or broader price increases feeding through the economy. That has allowed the bank to avoid an immediate rate hike. However, if energy prices remain elevated and the conflict continues, the case for tighter monetary policy may become harder to resist.

A sharper slowdown in economic activity could still persuade policymakers to delay action, but people familiar with the discussions suggest that this outcome is seen as unlikely. Financial markets are already pricing in several rate increases by the end of the year, although some economists believe the ECB may move more cautiously than investors expect.