ECB Officials Say Peace in Iran Isn’t Enough to Fix Energy Shock

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(Bloomberg) — European Central Bank officials are signaling that a US-Iran peace accord won’t necessarily stop them lifting interest rates further, even if it prevents a more pronounced overshoot in inflation.

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While policymakers including President Christine Lagarde welcome the prospect of oil shipments resuming through the Strait of Hormuz, they say significant economic havoc has already been inflicted and have no regrets about last week’s decision to hike.

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“Higher energy costs are likely to remain with us longer than many had hoped,” Governing Council member Peter Kazimir said. “Even with the just-announced US-Iran peace framework, the damage in the Middle East cannot be undone overnight.”

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The main concern is that it will take time to restore production capacity, repair infrastructure and get ships sailing again. Meanwhile, efforts to rebuild inventories will keep crude prices elevated.

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The risk for the 21-nation euro area is that companies and workers respond by raising selling prices and demanding higher pay, keeping inflation far above the 2% target. Most analysts still expect policymakers to do more, and traders are also betting on at least one additional quarter-point increase in the deposit rate this year, to 2.5%.

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The chance of a peace deal “is reducing some pressure on the ECB,” according to Greg Fuzesi, an economist at JP Morgan. “That does not, however, mean that pressure to hike has been reduced very significantly.”

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He still expects one more step in September after last week’s hike and wrote in a note to clients that risks are “modestly skewed toward a third one being delivered” before the end of the year.

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Comments by a number of officials seem to reinforce his view. 

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Portugal’s central-bank chief Alvaro Santos Pereira argued that it will take time for the situation around energy to normalize. His Latvian colleague Martins Kazaks pointed to a trend for multiple shocks to follow and build on top of each other and said “we also see that this current shock has not played out yet.”

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Bundesbank President Joachim Nagel added that expiring fiscal policy measures aimed at lowering energy prices may still bolster inflation in the months to come.

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“An end to the conflict does not necessarily mean an immediate end to the shock,” Governing Council member Gabriel Makhlouf said Tuesday in Dublin. “It remains to be seen how quickly supply chains normalize and energy prices adjust.”

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What Bloomberg Economics Says…

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“The deal doesn’t alter our view of the ECB’s rate path and we continue to forecast a 25-basis-point hike in September. If the cooling in energy prices persists, however, the risks to that call would shift to the downside. Uncertainty remains high, with the contours of any Iran nuclear deal still unclear.”