The latest macroeconomic projections, which were discussed by the Governing Council at its meeting, indicate that owing to the persistent conflict in the Middle East, inflation in the euro area will be higher this year than forecast in the previous projections, and economic growth slightly lower. Under the assumption of the normalisation of the situation in the Middle East and an easing of energy prices, our expectation is that the situation will gradually stabilise over the next two years.
Under these circumstances the Governing Council took the decision to raise the key interest rates by 25 basis points, after a long period of no change in the monetary policy stance. 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.
According to the projections, inflation will strengthen to 3.0% this year, which while core inflation persists at elevated levels is primarily a reflection of an uptick in energy price inflation caused by a spike in energy prices on global markets. Under the assumption of the normalisation of the situation in the Middle East and an easing of energy prices, inflation is expected to slow once again to 2.3% in 2027 and 2.0% in 2028. The high energy prices and increased uncertainty will put a brake on economic activity: real GDP growth in the euro area is forecast at 0.8% this year, 1.2% in 2027 and 1.5% in 2028.
In light of the huge uncertainty surrounding further developments in the Middle East, the Governing Council also discussed three alternative scenarios alongside the core projection. These show that different assumptions with regard to energy prices, uncertainty, and the strength of the secondary inflation effects would drive significant changes in the macroeconomic projections. The adverse and severe scenarios suggest that a further rise in energy prices on global markets – in the absence of a monetary policy response and amid stronger second-round effects – could lead to higher inflation over the medium term. Conversely the milder scenario suggests that a faster fall in energy prices as a result of a favourable outcome to the conflict in the Middle East could lead to a faster and more pronounced fall in inflation.
Banka Slovenije is scheduled to unveil its latest projections on Tuesday.
The rising and volatile energy prices and the rise in broad-based commodity price indices is affecting market inflation expectations, which remain elevated over the short term. The markets are consequently expecting the Governing Council to raise key interest rates this year. Yields on euro area government and private-sector bonds are fluctuating at higher levels than before the outbreak of the conflict in the Middle East. However, risk premiums fell in the private-sector bond segment. Global share indices have mostly risen since the end of April and remain close to their record highs, despite a partial correction in the last week, which was attributable to reduced optimism regarding further growth in the tech sector.
On the basis of this data, and mindful of all the scenarios, the Governing Council took the decision at yesterday’s meeting to raise the ECB’s key interest rates by 25 basis points after a long period of leaving the monetary policy stance unchanged. The interest rate on the deposit facility, which best reflects the monetary policy stance, now stands at 2.25%. In a situation of great uncertainty regarding the size and persistence of the energy shock, we believe that this interest rate level constitutes an appropriate response to the subsequent unfolding of events. 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.