European Central Bank amid soaring oil prices: Five major issues affecting policy direction

Notice that the European Central Bank will hold a meeting next Thursday, and traders are betting that the surging oil prices may prompt it to raise interest rates as early as this year. The renewed Middle East conflict has reignited concerns in the market about energy-induced inflation shocks, and at this time, the crisis triggered by the 2022 Russia-Ukraine conflict is still fresh in everyone's memory. Just a few weeks ago, decision-makers still believed they were in a "good state", but the current situation has made them uneasy. As one source told the media, the fate of the European Central Bank is currently "in the hands of military commanders". Here are five key questions that the market is focusing on: 1. What actions will the European Central Bank take next Thursday? Maintain interest rates at 2%. No one can currently predict how long the conflict will last or where energy prices will ultimately go, so the European Central Bank will acknowledge this uncertainty. President Lagarde has pledged to take all necessary measures to contain inflation. Rheinhardt Kruus, Chief European Economist at UBS, said: "They can no longer claim to be in a good state because they simply do not know if that's really the case. Everything will depend on how the situation unfolds next." 2. Does the war mean new inflation shocks? Inflation is expected to rise, but whether it will escalate into a "shock" will depend on the duration of the conflict and when oil shipments can pass through the critical Strait of Hormuz again. Oil prices have been fluctuating, approaching $120 earlier this week. Even at around $100, oil prices have risen by 35% since the start of the war, and have accumulated a 60% increase this year. Just this month, European natural gas prices have risen by nearly 60%. This will significantly boost inflation. An analysis by the European Central Bank in the past showed that a permanent 14% increase in oil and gas prices would lead to a 0.5% rise in inflation and drag economic growth down by 0.1%, with this impact lasting in the second year and tapering off afterwards. A derivative product used by investors to hedge against future inflation risks in the eurozone has soared from around 1.75% before the war to about 2.5%. Prior to the outbreak of the conflict, the European Central Bank had expected inflation rates this year and next to be below its 2% target, providing some cushion. Davide Oneglia, economist at TS Lombard, said that compared to 2022, considering that the current economy is far from the post-pandemic boom (when inflation was already rising) and the labor market is also weaker, the current risk leans more towards a setback in economic growth rather than a surge in inflation. 3. How will the European Central Bank deal with energy inflation shocks? At the moment, the prospect of cutting interest rates again this year seems to have disappeared, with traders betting on at least one rate hike this year. Given the painful lesson of 2022 - when the European Central Bank missed what later proved to be a historical inflation shock - the central bank is likely to avoid describing inflation as "temporary". Decision-makers seem prepared to remain calm and promise quick action, but this will only be done if they see risks of inflation solidifying in higher inflation expectations, wage demands, or commodity prices. Some economists say that oil prices need to stay above $100 for a few months and evidence of these "second-round effects" is required to support rate hikes. 4. What will the European Central Bank's new forecasts show? The new forecasts will only account for factors in the initial days of the war, so they are unlikely to fully reflect the extent of the surge in energy prices. The real focus will be on any "scenario analysis" provided by the European Central Bank. Deputy Governor Luis de Guindos said that such an analysis is likely to emerge, just like during the Russia-Ukraine conflict. Before the conflict, oil prices had already started rising and euro area inflation unexpectedly jumped last month, putting upward pressure on the forecasts made by the European Central Bank in December. 5. Will Lagarde complete her term at the European Central Bank? European Central Bank President Lagarde is trying to quell speculation about her potential early departure, but has not given a clear denial. If she were to leave early, it would allow French President Emmanuel Macron to intervene in the appointment of her successor. The possibility of an early departure remains open. Investors see Klaas Knot, Governor of the Dutch Central Bank, and De Guindos from Spain as possible candidates. Knot is seen as hawkish but pragmatic, while De Guindos leans slightly towards dovishness. Neither are expected to change the operation of the European Central Bank. Analysts point out that given Lagarde was not initially a candidate in 2019, the successor is still unclear; if inflation rises, the new leader may leave a more personal mark. However, Deutsche Bank stated that the new inflation threats increase the likelihood of Lagarde fulfilling her full term until October 2027.