FXTRADING Financial Focus (Asia-Pacific 06/22)ECB Warns on Core Inflation, More Hikes Possible

The European Central Bank delivered its first rate hike in three years last week, but discussions over the future policy path are far from over. Pierre Wunsch, Governor of the National Bank of Belgium and a member of the ECB Governing Council, believes it is too early to let down the guard simply because energy prices have eased. Although the temporary US-Iran agreement has pushed oil prices sharply lower and reduced concerns over energy-driven inflation, whether inflation has truly returned to a manageable range will depend on price developments across a broader range of sectors.

In his view, the importance of energy factors is gradually diminishing, while domestic inflation pressures such as services and wages deserve greater attention. Recent data showed euro area services inflation rising from 3.0% to 3.5%, a development that has made some policymakers uneasy. If price increases begin spreading to more sectors, another round of policy tightening cannot be ruled out even if oil prices continue to decline.

Wunsch said that if upcoming data continue to show little sign of moderation in services prices and wage growth, he would prefer acting sooner rather than waiting until inflation becomes more deeply entrenched. He believes that, if necessary, another 25 basis point increase would serve as an insurance move, with room to consider easing policy later once inflation trends weaken again.

However, there are still differences within the ECB regarding the timing of any further action. Some officials prefer waiting until September, arguing that more data are needed to confirm current trends. With oil prices already having fallen noticeably, consecutive rate hikes could unnecessarily increase downside risks to economic growth. Markets generally expect another ECB rate hike in either September or October, while further tightening early next year remains a possibility.

Interestingly, Wunsch himself acknowledged that easing tensions between the United States and Iran could eventually lead to a renewed global oil surplus over the next year. He previously warned colleagues that, as geopolitical risks fade, oil prices could potentially return to levels seen before the conflict. Against the backdrop of slower wage growth, some observers also believe the ECB could have opted to leave rates unchanged last week and wait to assess the impact of lower energy prices.

Nevertheless, he continues to support the ECB's decision to raise rates by 25 basis points last week. In his view, policymakers were facing renewed inflation risks and elevated uncertainty at the time, making pre-emptive action reasonable. As inflation rises, real interest rates have not tightened significantly. Should price pressures ease later on, the ECB would still retain room to cut rates, making policy flexibility more important than an early shift in direction.

Going forward, the focus of euro area monetary policy may gradually shift away from energy prices and toward services inflation and wage growth. If core inflation remains stubborn, hawkish voices within the ECB could become more influential, keeping borrowing costs for businesses and households elevated and posing challenges to the pace of economic recovery. From FXTRADING's perspective, as energy-related risks ease, future ECB policy decisions are likely to depend increasingly on services prices and wage data. If core inflation continues to show resilience, the central bank may keep the door open to further tightening, while shifting policy expectations are likely to reflect persistent differences in views regarding the outlook for growth and inflation.

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