According to the latest data, economic growth in the euro area has slowed somewhat, largely because of the war in the Middle East. At the same time the higher energy prices caused by developments in the Strait of Hormuz are driving inflation up slightly. Meanwhile the medium-term inflation expectations remain relatively stable, with a prevailing view that the war in the Middle East will end quickly enough to allow inflation to return to our target rate over the medium term.
These conditions allowed us to leave interest rates unchanged at the latest monetary policy meeting, but we will examine the situation again at upcoming meetings. At that time more information will be available, and it might be clearer how the war will unfold; we will be able to analyse the impact of the shock through the prism of the updated macroeconomic projections.
The latest macroeconomic data shows the effects of the energy shock gradually being reflected in the euro area economy. Inflation strengthened in March compared with the period before, and growth in economic activity is weakening. According to the Eurostat flash estimate, inflation rose to 3.0% in April, driven largely by high energy price inflation of 10.9% as the direct consequence of the worsening situation in the Middle East. Core inflation excluding energy and food meanwhile slowed to 2.2%. GDP in the euro area in the first quarter of this year was up 0.1% in real terms, but the current values of leading indicators, such as the consumer confidence indicator and the PMI, point to a worsening outlook for economic growth at the beginning of the second quarter. Future economic developments in the euro area remain largely dependent on developments in energy prices on global markets and the unfolding of events in the Middle East.
The situation on the financial markets remains heavily dependent on the conflict in the Middle East, while the general level of uncertainty remains elevated. The greatest exposure is on the commodities markets, where energy prices are persisting at high levels. The high energy prices and the associated increase in inflation risks are also affecting market expectations of the ECB tightening interest monetary policy this year. Yields on euro area government bonds are consequently higher than before the outbreak of the war. Risk premiums in the private bond market fell slightly following the ceasefire, but remain higher than before the war began. European share indices also remain at lower levels than before the outbreak of the war, given the persistent uncertainty.
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.