ECB Risks Longer Inflation Undershoot as EU Delays Carbon Rules

9zc1m6jechk8c0snn2gk5b4v_media_dl_1.png EU, Bloomberg

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(Bloomberg) — A delay to the European Union’s new carbon-pricing system looks set to weigh on the outlook for inflation, potentially reviving calls for more interest-rate cuts.

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To help soften the impact of the bloc’s green transition, governments and lawmakers want to postpone rollout of Emissions Trading System 2, which imposes costs on polluters and is likely to make things like fuel more expensive.

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Doing so would probably mean consumer prices rise less than currently forecast in 2027 — leaving the European Central Bank staring at another undershoot of its 2% target on top of the one it already expects next year.

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While ECB officials have largely agreed that borrowing costs don’t need adjusting to tackle existing challenges — including global trade and fiscal strain in parts of the region — the holdup in ETS2 could prompt calls from some to resume monetary easing.

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“Without ETS2 taking effect in 2027, the inflation undershooting is likely to be larger in 2027, all else equal,” said Rune Johansen, an economist at Danske Bank. This “is an argument for favoring another cut,” he said, stressing that some officials would still push back.

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The ECB’s latest quarterly outlook envisages inflation of 1.7% and 1.9% over the next two years. Bloomberg Economics reckons ETS2 provides a lift of 0.2 percentage point or more in 2027. 

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What Bloomberg Economics Says…

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“Without the boost from ETS2, the forecasts would likely be closer to our own. With both the inflation impact and national implementation uncertain, the staff projections may lean on the optimistic side.”

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—David Powell and Simona Delle Chiaie. Read here for full INSIGHT. 

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Before the next batch of forecasts, others have reached similar conclusions. The “concentrated effect in 2027 is now likely to be removed from the staff projections in December and replaced by a smaller effect in 2028,” JPMorgan’s Greg Fuzesi said.

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The situation highlights how uncertainty beyond headline issues like Donald Trump’s tariffs and the Russia’s war in Ukraine is also complicating the ECB’s job. Six years on, commitment to the EU’s Green Deal is waning as governments ramp up defense capabilities and prioritize economic growth.

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While sticking by a pledge to slash emissions by 2040, politicians fear higher energy costs could trigger a voter backlash. The ETS system caps emissions and lets companies trade allowances, with ETS2 designed to extend the concept to buildings and road transport from energy generation, aviation and others.

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Quizzed last month about a delay, ECB President Christine Lagarde downplayed the danger, citing a European Commission proposal to spread the rollout over a longer period while still starting in 2027.