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The European Central Bank will have to raise interest rates further if oil prices continue to hover around $100 a barrel until the end of the year, one of its top policymakers has warned.
Speaking to the FT after the ECB on Thursday increased borrowing costs for the second time this year, Austria’s central bank governor Martin Kocher warned that “the risk of inflation is higher than it was a few months ago” as tensions in the Middle East drag on and energy prices remain high.
Oil prices have surged more than 45 per cent to above $100 a barrel since the collapse of a ceasefire between the US and Iran in early July. European gas prices have almost doubled to just under €80 per megawatt-hour since June.
“If oil and natural gas prices move more towards the adverse scenario, then . . . monetary policy would have to take those developments into account,” Kocher said, adding that inflation risks would then accelerate even further.
The ECB raised borrowing costs by a quarter point to 2.5 per cent on Thursday, its second move in three months.
Among the G7 central banks, only the ECB and Bank of Japan have so far responded to the inflationary pressures unleashed by the Iran war, although traders on Friday increased bets on a rate rise from the US Federal Reserve next week.
In its most adverse scenario for the path of inflation, the ECB assumes an average oil price of $99 a barrel between October and December and gas prices at €77 per MWh.
If that occurs, inflation would rise to 3.2 per cent next year under the ECB’s modelling, meaning it would miss its 2 per cent medium-term target for two consecutive years.
Kocher stressed that a temporary increase in inflation could be unavoidable as the surge in oil prices is a supply shock outside the central bank’s control.
“Monetary policy obviously cannot influence oil prices,” he said, adding that this meant Europeans would “have to live with somewhat elevated inflation in the short term”.
But he stressed that “this period has to be short” and inflation would need to return to the ECB’s targeted level “within about a year”.
The ECB’s baseline scenario assumes that inflation will fall to 2 per cent at the end of next year if oil prices average about $90 a barrel in the fourth quarter.
“We must do everything we can to achieve our inflation target,” Kocher said, adding that it was “too early to say anything about” the ECB’s stance at its next meeting at the end of October, “let alone” when it meets in December.
Investors are betting on another quarter-point rate increase to 2.75 per cent by the end of the year, followed by yet another in the first half of 2027, according to Reuters data. The ECB will not hold a monetary policy meeting in November.
Kocher said it was unpredictable at this point “what the situation will look like in October”, pointing to previous episodes where market bets on future interest rates changed quickly.
He stressed that the ECB’s policy would be shaped by high and rising inflation risks “unless there are surprising developments”.
For now, Kocher said there was no clear evidence that higher energy costs were feeding into broader price or wage increases. But he warned that such “second-round effects” would become more likely the longer that tensions in the Middle East persist and energy prices remained elevated.
“We are watching this extremely closely, in particular the trends in wages and compensation per employee,” he added.
