(May 29): The Iran war may push medium-term inflation expectations among euro-area consumers higher, according to a European Central Bank (ECB) blog post that appears to underpin the case for hiking interest rates.
The chances that households will anticipate more rapid increases in prices have also increased after the 2022 price spike that followed Russia’s invasion of Ukraine and earlier geopolitical tensions left a “double scar”, Friday’s post said.
Policymakers are particularly attentive to such expectations as they look to prevent the war-induced surge in energy costs from spilling over into broader inflation through wages and corporate price-setting. While short-term price outlooks have already risen significantly, movements in the medium to longer term have been smaller.
Officials are widely expected to raise borrowing costs by a quarter-point in two weeks, with euro-area inflation already at 3% and likely to quicken further.
“When looking ahead, consumers tend to extrapolate from their short-term to their medium-term inflation expectations, and they may have yet to witness the full pass-through to prices at the retail level,” Friday’s blog said. “As a result, there is certainly a risk of further upward revisions in medium-run inflation expectations in the future.”
See also: ECB expands probe on private credit to more banks as fears mount — Bloomberg
Adding to that, memories of 2022’s surge in prices and prolonged effects of geopolitical shocks “may reinforce each other”, the authors Olivier Coibion, Dimitris Georgarakos, Yuriy Gorodnichenko, Geoff Kenny, Justus Meyer and Trixi Pairan wrote.
While “the general shift towards a more stagflationary outlook is, so far, somewhat less pronounced” than four years ago, they cautioned that current data “provide only a snapshot”.
With consumers highly attentive to economic news, “the evidence suggests that trust in the ECB acts as a buffer against the de-anchoring of inflation expectations”, the post argued. “Maintaining credibility and effective communication therefore remain essential, especially in volatile macroeconomic and geopolitical environments.”
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