ECB Rate-Hike Bets Test Officials’ Attempts to Keep Their Cool

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(Bloomberg) — European Central Bank efforts to project calm over war and inflation are being tested as markets price in a hike in interest rates this year.

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Traders who until recently expected borrowing costs to stay at 2% into 2027 now see surging energy costs as a potential threat to prices in Europe — and one that could force the ECB’s hand.

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In public, officials portray a steady-as-it-goes approach to interest rates. Privately, however, policymakers speaking on condition of anonymity are alert to the risks and keen to stay nimble — even if rapid action is unlikely.

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The challenge is to acknowledge mounting dangers stemming from President Donald Trump’s military campaign in Iran without fueling a further tightening in financial conditions.

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The situation recalls 2022, when Russia’s invasion of Ukraine sent inflation soaring and the ECB defied market expectations for higher borrowing costs before belatedly yielding.

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That’s a comparison that officials like Bank of France Governor Francois Villeroy de Galhau and his Dutch counterpart Olaf Sleijpen would rather avoid, with the latter insisting the circumstances are “different” now.

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“The ECB is clearly looking at it, but won’t necessarily react, while markets try to front-run developments,” Spyros Andreopoulos at Thin Ice Macroeconomics said. “The situation is in flux and policymakers themselves try to see what’s appropriate next.”

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The change in rate wagers is taking place in tandem with a global shift in perceptions of the risks to monetary policy — one that’s reduced expectations of a cut by the Bank of England in 2026 and helped drive fluctuating bets this week for the Federal Reserve.

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The 2022 episode remains sensitive inside the ECB, reinforcing criticism that its consensus-driven, process-heavy set-up can slow decision-making. It added to a narrative of earlier missteps, including rate increases in 2008 and 2011 that were later reversed.

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Chief Economist Philip Lane, the cheerleader for the central bank’s low-rate policy in 2021 and early 2022, subsequently found himself defending that record. He even appeared to cite the prior hiking mistakes when doing so.

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“The post-hoc thing — ‘well we’ve seen inflation therefore I conclude you were too slow in hiking’ — I’d like to counterbalance that with all those episodes in history where maybe some central banks hiked too quickly, and what happened then,” he told detractors in March 2023. Later that year, he insisted the delay in raising rates didn’t make a “massive difference.”

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Earlier this week, when asked by the Financial Times whether the ECB is scarred by the inflation crisis a few years ago, Lane immediately replied that officials “carry two scars,” with the “chronic, below-target inflation before the pandemic” being the second. “That is still in the memory bank,” he said.