The economic situation in the euro area was favourable in the early part of the year, but the instability in the Middle East and the sharp rise in energy prices on global markets are introducing a huge degree of uncertainty around the future economic picture. All of this is reflected in the ECB’s latest projections, whose baseline scenario is already expecting slightly higher inflation and lower economic growth this year.
Under these circumstances, when it is not yet clear how the new conflict will unfold and what the scale of its impact on the economy will be, the Governing Council of the ECB decided to again leave interest rates unchanged. The interest rate on the deposit facility, which best reflects the monetary policy stance, thus remains at 2.0% for the sixth consecutive meeting. With the broader geopolitical and economic environment even more uncertain now than in previous months, the Governing Council’s next steps will continue to be based on an assessment of the inflation outlook and the accompanying risks, the dynamics of underlying inflation, and the strength of monetary policy transmission.
The latest macroeconomic projections, which were discussed by the Governing Council at its meeting, indicate that as a result of the outbreak of war in the Middle East, inflation will be slightly higher than forecast in the previous projections, and economic growth lower. Inflation is forecast to rise to 2.6% this year, primarily in reflection of the expected uptick in energy price inflation driven by a surge in prices of oil and natural gas on global markets. Under the assumption of the normalisation of the situation in the Middle East, inflation is expected to slow to 2.0% in 2027 and 2.1% in 2028. The high energy prices and increased uncertainty will put a brake on economic activity: real GDP growth is forecast at 0.9% this year, 1.3% in 2027 and 1.4% in 2028.
In light of the extreme uncertainty surrounding further developments in the Middle East, the Governing Council also discussed two alternative scenarios alongside the core projection. These suggest that a prolonged war in the Middle East could drive a further rise in energy prices on global markets, which – in the absence of a monetary policy response and amid stronger second-round effects – could lead to higher inflation over the medium term.
The outbreak of war in the Middle East also had a major impact on the financial markets. The adverse geopolitical situation has driven increased volatility on the financial markets, and a deterioration in liquidity. The markets expect energy prices to put upward pressure on inflation in the euro area, and expectations that the Governing Council might raise interest rates this year are consequently beginning to be priced in. Yields on government and private-sector securities rose, and risk premiums also edged upwards. Share indices meanwhile fell. Despite increased volatility and worsening liquidity, the financial markets in the euro area are working well, and are providing access to financial resources.
In light of this data, the Governing Council decided at yesterday’s meeting to once again leave interest rates unchanged. The interest rate on the deposit facility, which best reflects the monetary policy stance, thus remains at 2.0%. The Governing Council’s future decisions will remain focused on seeing inflation stabilise at its 2% target rate over the medium term. The next steps will be based on an assessment of the inflation outlook and the risks surrounding it, the dynamics of underlying inflation, and the strength of monetary policy transmission. The monetary policy stance will continue to be decided on a meeting-by-meeting basis.