By Yoruk Bahceli and Stefano Rebaudo LONDON, March 13 (Reuters) - The European Central Bank meets next Thursday, with traders betting that surging oil prices could push it to hike interest rates as
At the mercy of oil: Five questions for the ECB
By Yoruk Bahceli and Stefano Rebaudo
LONDON, March 16 (Reuters) - The European Central Bank meets on Thursday, with traders betting that surging oil prices could push it to hike interest rates as early as this year.
War in the Middle East has rekindled fears of an energy-driven inflation shock at a time when memories of the 2022 crisis following Russia's invasion of Ukraine remain fresh.
Jolted from the 'good place' policymakers reckoned they were in just weeks ago, the ECB outlook is now "in the hands of military generals," as one source put it to Reuters.
Five Key Questions for Markets
1. What will the ECB do on Thursday?
Hold rates at 2%. It's anybody's guess how long the conflict will last and where energy prices end up, so the ECB will acknowledge the uncertainty and President Christine Lagarde has already promised to do everything needed to keep inflation in check.
Expert Insight
"They can no longer say they're in a good place because they don't know whether they're in a good place," said UBS chief European economist Reinhard Cluse. "It will all depend on what comes next."
2. Does the war mean a new inflation shock?
Inflation is expected to rise, but whether that turns into a shock will depend on the duration of the conflict and when tankers can travel through the key Strait of Hormuz again.
Oil and Gas Price Movements
Oil prices have seesawed, nearing $120 last week .
At around $105 on Monday, they are still up over 40% since the war started and 70% higher this year. European gas prices are up around 60% this month alone.
Impact on Inflation and Growth
This would raise inflation significantly. A past ECB analysis showed that a permanent 14% oil and gas price jump would raise inflation by 0.5% and hit growth by 0.1%, having a similar impact for a second year before fading.
A derivative that investors use to hedge euro zone inflation risk over the next two years has jumped to around 2.70% from 1.75% before the war.
ECB's Previous Expectations
Before the conflict, the ECB expected inflation to undershoot its 2% target this year and next, providing some buffer.
Comparison to 2022
Compared to 2022, risks are tilted more to a growth hit than an inflation jump, TS Lombard economist Davide Oneglia said, given the economy is far from a post-pandemic boom where inflation was already rising. The jobs market is also weaker.
3. How would the ECB react to an energy inflation shock?
For now, what's clear is the prospect of another rate cut this year looks off the table and traders are fully pricing in one rate hike this year and a considerable chance of a second move by year-end.
ECB's Approach and Lessons from 2022
Burnt by the experience of 2022, when it missed the onset of what turned out to be a historic inflation shock, the ECB is likely to steer clear of describing inflation as "transitory".
Policymakers look set to keep a cool head but have promised swift action but only if they think inflation is at risk of getting entrenched in higher inflation expectations, wage demands or prices of goods.
Conditions for Rate Hikes
Some economists say it would take oil prices above $100 for several months and evidence of those second-round effects to warrant rate hikes.
4. What will the ECB's new projections show?
The projections will only factor in the first few days of the war, so are unlikely to capture the full extent of the spike in energy prices. The real focus will be on any scenario analysis the ECB presents.
Scenario Analysis and Pre-Conflict Trends
Vice President Luis de Guindos said such analysis was likely as was the case when Russia invaded Ukraine.
Oil prices had already started rising pre-conflict and euro zone inflation unexpectedly jumped last month, putting upward pressure on projections the ECB presented in December.
5. Will Lagarde see out her term at the ECB?
ECB chief Lagarde has tried to dampen speculation that she might leave her post early while offering no outright denial. This would allow French President Emmanuel Macron's involvement in appointing her successor.
Potential Successors
The door remains ajar to an early departure. Investors see former Dutch central bank chief Klaas Knot and Pablo Hernandez De Cos, the previous head of Spain's central bank, as two likely candidates. Knot is seen as hawkish but pragmatic and De Cos a bit more dovish. Neither is seen changing the way the ECB operates.
Uncertainty Around Leadership
Analysts note a successor is up in the air given Lagarde herself wasn't a candidate initially in 2019 and a new leader could leave more of their mark if inflation rises.
Chances of Lagarde Completing Her Term
However, a new inflation threat raises the chance that Lagarde might see out her full term until October 2027, Deutsche Bank said.
(Reporting by Yoruk Bahceli and Stefano Rebaudo; Editing by Dhara Ranasinghe, Gareth Jones and Bernadette Baum)
