ECB Accounts: Middle East risks keep ECB cautious on rates, inflation spillovers

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The European Central Bank kept interest rates unchanged and reiterated a meeting-by-meeting approach.
The war in the Middle East increases upside risks to inflation and downside risks to growth.
Policymakers focus on potential second-round effects through wages, prices and inflation expectations.

The European Central Bank (ECB) kept its interest rates unchanged in March, and the meeting accounts released on Thursday show a central bank determined to preserve flexibility in an environment marked by heightened uncertainty. Policymakers stressed that it is still too early to draw firm conclusions about the macroeconomic consequences of the war in the Middle East, while warning that the energy shock could still pose inflation risks.

The tone of the accounts remains cautious but firm. The ECB noted that “the option value of waiting was high”, which justified leaving policy rates unchanged at this stage. At the same time, policymakers reiterated that they stand ready to act if the medium-term inflation outlook deteriorates. In practice, the Governing Council continues to avoid committing to a specific rate path and maintains a data-dependent, meeting-by-meeting approach.

The ECB said the war creates “upside risks for inflation and downside risks for growth”, mainly through higher Oil and Gas prices, potential disruptions to supply routes and the negative impact on real incomes. Policymakers also highlighted that a longer or more intense conflict could prolong the energy shock well beyond what current Futures markets suggest.

The March staff projections reflect this shift in tone. Headline inflation is now expected to average 2.6% in 2026, 2% in 2027 and 2.1% in 2028. The upward revision for 2026 mainly reflects higher energy prices, while underlying inflation was also revised slightly higher, suggesting that the ECB does not rule out a broader pass-through of the shock.

Looking ahead, the key issue for future meetings will be the extent of indirect and second-round effects. The accounts show that policymakers intend to closely monitor wage developments, firms’ pricing behaviour, household inflation expectations and potential supply-chain disruptions. Several members noted that memories of the 2022 inflation surge could lead workers and firms to react more quickly if energy prices remain elevated.

At the same time, the ECB does not believe that the current shock necessarily mirrors the situation seen in 2022. The starting point is considered more favourable, with inflation already close to the 2% target, long-term inflation expectations still well anchored and weaker demand conditions compared with the previous energy shock. This explains why policymakers prefer to wait for more data before adjusting the policy stance.

Overall, the meeting accounts send a clear signal that the ECB is not shifting toward tightening for now, but its level of vigilance has increased significantly. As long as the energy shock proves temporary and second-round effects remain limited, the current policy stance may hold. However, a more persistent rise in energy prices or stronger spillovers into wages and broader prices could quickly alter the balance of the monetary policy debate.

Market reaction

The release had little impact on the Euro, with EUR/USD down 0.14% on Thursday, trading around 1.1780 at the time of writing.

ECB FAQs

What is the ECB and how does it influence the Euro?

The European Central Bank (ECB) in Frankfurt, Germany, is the reserve bank for the Eurozone. The ECB sets interest rates and manages monetary policy for the region. The ECB primary mandate is to maintain price stability, which means keeping inflation at around 2%. Its primary tool for achieving this is by raising or lowering interest rates. Relatively high interest rates will usually result in a stronger Euro and vice versa. The ECB Governing Council makes monetary policy decisions at meetings held eight times a year. Decisions are made by heads of the Eurozone national banks and six permanent members, including the President of the ECB, Christine Lagarde.

What is Quantitative Easing (QE) and how does it affect the Euro?

In extreme situations, the European Central Bank can enact a policy tool called Quantitative Easing. QE is the process by which the ECB prints Euros and uses them to buy assets – usually government or corporate bonds – from banks and other financial institutions. QE usually results in a weaker Euro. QE is a last resort when simply lowering interest rates is unlikely to achieve the objective of price stability. The ECB used it during the Great Financial Crisis in 2009-11, in 2015 when inflation remained stubbornly low, as well as during the covid pandemic.

What is Quantitative tightening (QT) and how does it affect the Euro?

Quantitative tightening (QT) is the reverse of QE. It is undertaken after QE when an economic recovery is underway and inflation starts rising. Whilst in QE the European Central Bank (ECB) purchases government and corporate bonds from financial institutions to provide them with liquidity, in QT the ECB stops buying more bonds, and stops reinvesting the principal maturing on the bonds it already holds. It is usually positive (or bullish) for the Euro.