ECB's Asymmetric Risk: Second-Round Inflation Effects Could Force Faster Hike Than Market Prices In

The market's prevailing sentiment heading into the ECB's April 30 meeting is one of cautious wait-and-see. The central bank's March meeting left rates unchanged, explicitly adopting a data-dependent approach amid heightened uncertainty from the Middle East conflict The war in the Middle East has made the outlook significantly more uncertain. This stance has been mirrored by officials, with Governing Council member Olaf Sleijpen stating the next discussion will be between a hike or a hold, noting that while there will be new data, it will be limited The next discussion will be between increasing interest rates or holding them steady. This sets the stage for a meeting where the consensus view appears to be a hold.

Market expectations, as reflected in ECB interest rate probabilities, indicate no clear consensus for a hike. The data shows a wait-and-see stance aligning with the central bank's own approach. In reality, the market is pricing in a continuation of the current policy, with the primary question being whether the next move is up or stay the same.

Yet, this cautious consensus may be underestimating the asymmetric risk. The ECB's own staff projections point to a baseline where headline inflation averages 2.6% in 2026, a notable increase driven by higher energy prices Inflation has been revised up compared with the December 2025 Eurosystem staff macroeconomic projections for the euro area. The central bank's scenario analysis warns that a prolonged energy shock could trigger stronger and more persistent second-round effects, pushing inflation higher and growth lower than the baseline. The market's current pricing for a hold assumes these risks are contained. The real vulnerability is that second-round effects-where higher energy prices feed into broader wage and price pressures-could spread faster than they did in 2022, forcing a more aggressive policy response than the current probabilities suggest.

The Asymmetric Risk: Hike vs. Hold

Two key ECB policymakers have signaled this heightened concern. Dutch Governor Olaf Sleijpen noted that the current environment is different because everyone is more alert now so shocks can easily spread throughout the economy. He pointed to the war in the Middle East as a driver of higher energy prices, and stressed that the ECB will have more information on second-round effects by its April 30 meeting. Second-round effects occur when firms raise prices to offset higher input costs and workers demand higher wages, a dynamic the ECB is watching closely.

The risk is asymmetric. The market is pricing in a hold, but the ECB's own scenario analysis warns that these effects could spread faster than they did in 2022. Slovenian policymaker Primoz Dolenc captured this worry, stating that the euro zone economy may already be on the "adverse" path outlined by the European Central Bank. He believes inflation expectations and price-setting behavior are being shaped by fresh memories of the 2022 spike, meaning second-round effects might not take as long to take hold. In his view, the baseline scenario now looks more like a best-case outcome, while the adverse path is becoming the new reality.

This sets up a clear tension. The ECB has explicitly warned it may need to raise interest rates if the price surge spreads across the broader economy. The central bank's mandate is to preserve its credibility, and acting quickly if expectations shift is seen as crucial. Yet, officials like Dolenc also acknowledge that we cannot say today whether we'll have enough information by April 30. The data flow in the coming weeks will be critical.

The bottom line is one of second-level thinking. The market is pricing in a hold, but the ECB's internal warnings suggest the risk of a faster hike is rising. If energy prices persist and second-round effects materialize more quickly than in 2022, the central bank's credibility could be on the line. The April meeting may not yield a decision, but it will be a crucial data point on whether the economy is indeed on the adverse path, and whether the ECB's next move needs to be sooner rather than later.

Catalysts and What to Watch

The key watchpoint is the April 30 meeting itself, where the ECB must act on limited data about second-round effects. As Governing Council member Olaf Sleijpen noted, the central bank will have new data then, but that is limited. The complete picture won't have emerged by the end of April. The bank will work with the information available, but the risk is that it may not be enough to definitively rule out the adverse scenario.

Investors should monitor core inflation (excluding energy and food) and wage growth data for signs of the adverse scenario becoming the new baseline. These are the critical indicators the ECB will use to assess whether second-round effects are taking hold. As Sleijpen explained, inflation expectations and producer prices would be the key indicators at the April meeting. If these data points show a rapid transmission of energy cost pressures into broader price and wage-setting behavior, it would signal that the economy is moving faster down the adverse path than the baseline.

The ECB's forward guidance on whether it views the adverse scenario as the new baseline will be a critical signal for market sentiment. Slovenian policymaker Primoz Dolenc captured this shift in outlook, stating that the baseline scenario appears to be more like a best-case scenario for the future and probably the current adverse scenario is more likely to be our next baseline. His view is that second-round effects might not take as long to take hold as in 2022, due to fresh memories of rapid price rises. The market's current pricing for a hold assumes the baseline remains the baseline. If the ECB's guidance suggests otherwise, it would confirm that the central bank sees a higher probability of a faster hike, which could quickly reset expectations and market pricing.