Source: Jin Shi Data

According to committee member Peter Kazimir, the Russia-Ukraine conflict and its impact on inflation may force the European Central Bank to raise interest rates earlier than expected.

Although the European Central Bank is currently in a "favorable position" and does not need to take action at next week's meeting, Kazimir is concerned that the inflation shock experienced in the region in 2022 has lowered the threshold for businesses to raise prices and for consumers to demand salary increases. He noted that the upward risks are clearly dominating the economic outlook.

Kazimir stated during an interview in Frankfurt on Tuesday: "We need to stay calm at the moment, but I believe the European Central Bank's response may be closer than many think. I do not want to speculate about April or June, but we will be ready to take action if needed."

Traders are leaning towards raising interest rates in June or later, betting that the spike in energy costs due to the conflict in the Middle East will prompt the European Central Bank to act. However, after Trump indicated that the conflict might "end soon," they revised down their bets for two rate increases of 25 basis points this year. After Kazimir's speech, the euro maintained its upward momentum.

European Central Bank officials have urged patience but also recognize that the progress they have made toward restoring price stability is now under threat, following the eurozone's inflation rate soaring above 10% four years ago. Economic growth also faces risks, and market sentiment has already begun to deteriorate.

Kazimir, who also serves as the governor of the Slovak central bank, remarked: "The situation is very turbulent, one might even say dramatic, and the panic of markets and decision-makers could become a risk."

He hinted that he was dissatisfied with the situation even before the events in the Middle East unfolded, as service prices exhibited stickiness, commodity costs were not decreasing quickly enough, and margins were expanding. He is now even more concerned. He believes that the balance of inflation risks has clearly shifted to support the upside, and people can forget all discussions about inflation being below target.

According to Kazimir, inflation expectations, as an early indicator of the long-term consequences of price shocks, have begun to rise. He pointed out that businesses still vividly remember the inflation years, and the speed of passing on high costs could be much faster than in 2022, while the public's demand for salary increases could also happen more quickly than in the past.

Signs of such second-round effects may prove that rate hikes are warranted. Decision-makers now appear more prepared than in 2022, when the remnants of quantitative easing and commitments to loose policy constrained their actions.

Kazimir stated: "If necessary, we can respond more quickly. We must remain flexible, and we have learned our lessons."

He argued that the European Central Bank's quarterly forecasts released this month and in June are not prerequisites for raising interest rates. He explicitly stated that he has no objections to raising rates even without new forecasts. It is clear that further rate cuts are not on the table now.

Kazimir's commitment to flexibility was echoed by his colleagues. Austria's Martin Kocher emphasized on Tuesday that the European Central Bank reserves "all options"; Greece's Yannis Stournaras advocated for maintaining "flexibility." Meanwhile, Lagarde, France's Villeroy, and Latvia's Martins Kazaks all stated that the European Central Bank will not allow inflation to spiral out of control.

Meanwhile, this Slovak official is not the only one hinting at potential rate hikes. Estonia's Madis Muller noted that the possibility of a rate hike has increased; Germany's central bank president Nagel stated that officials will decide this month "whether the current monetary policy stance remains appropriate."

Despite the uncertainties, Kazimir remains "fairly optimistic" about growth and is not "too worried" about stagflation. He warned governments not to protect consumers and businesses from high energy costs through expensive follow-up support measures, considering the fragile fiscal situations in some member countries.

He said: "There is no doubt that governments will come up with ideas on how to provide relief. I strongly advise against this and encourage them to take very targeted and time-limited measures, but this has never happened in the past."

Finally, Kazimir expressed confidence that Lagarde will complete her term. He pointed out that Lagarde has clearly indicated her commitment to completing her term, which sends a clear signal to the committee. European institutions need leadership at this critical juncture, and doubts about whether the leadership is in place are not helpful.