ECB official Villeroy flags rising uncertainty from Iran war

ECB Governing Council member François Villeroy de Galhau has highlighted growing economic uncertainty stemming from the escalating conflict in the Middle East, emphasizing that the duration of hostilities will critically shape inflation and growth outcomes. Since the war began, crude oil prices have surged over 10%, while natural gas prices have risen by 60%, echoing the energy shocks seen during the 2022 Russia-Ukraine war. Rising energy costs threaten to strain household budgets and corporate margins, potentially slowing eurozone growth and complicating the ECB's inflation-targeting mandate.

Villeroy noted that prolonged conflict could trigger "second-round effects," such as wage-price spirals, as businesses and workers adjust to persistent higher costs. This contrasts with a short-lived war, which might result in temporary price spikes without embedding inflationary pressures into broader economic expectations. The ECB's dilemma mirrors its response to the 2022 energy crisis, when delayed rate hikes allowed inflation to peak at over 10%. "2026 is not 2022," Villeroy clarified, citing tighter monetary policy and differing global supply dynamics today.

Market expectations reflect this uncertainty. Interest rate futures now price in a higher probability of an ECB rate hike this year, up from near-zero expectations in early March. However, policymakers remain divided: while some, like ECB Vice President Luis de Guindos, suggest the conflict may resolve quickly, others, including Bank of Finland's Olli Rehn, warn of regional escalation. The ECB's next policy meeting on March 19 will assess whether energy shocks necessitate a shift in its current "wait-and-see" approach.

For now, the central bank's response hinges on one variable: how long the war lasts.