By Paul Hannon
Europe's central bankers will be in a familiar but uncomfortable position when they meet to decide policy Thursday; waiting for the fog of war to clear a little before they can pick out a safe path forward.
Policymakers at the European Central Bank, the Bank of England, and their counterparts in Sweden and Switzerland are expected to leave their key interest rates unchanged.
As the conflict initiated by the U.S. and Israel extends into a third week, it is already likely that economic growth will be weaker and inflation higher this year than European central bankers had anticipated.
The magnitude of that divergence will depend on the duration of the conflict and how long the Strait of Hormuz remains closed to most shipping.
"We expect the ECB to acknowledge that the economic fallout from the Middle East conflict remains highly uncertain at this stage, even if the direction of travel points to firmer near-term inflation and weaker economic activity," economists at Barclays wrote in a note to clients.
Like their global counterparts, most ECB policymakers have been here before; four years ago, they were trying to understand the implications of Russia's full-scale invasion of Ukraine. In late 2023 they pondered the impact of the Gaza conflict with the central bank's economists providing forecasts for a scenario in which the Strait of Hormuz was closed.
They are likely to revisit those forecasts, providing some guidance on the potential damage caused by the conflict without committing to a rate path. Back in December 2023, the ECB's economists calculated that a rise in oil prices to $130 a barrel from $80 alongside higher natural gas prices would lower economic growth by almost three-quarters of a percentage point while boosting inflation by just short of a percentage point.
Policymakers are likely to assure Europeans that they will not let inflation get out of control with still-fresh memories of 2022's surge in energy and food prices.
"We will not allow inflation to take hold," Bank of France Governor François Villeroy de Galhau said in a radio interview last week.
While the ECB had been expected to leave its key interest rate at 2% even before the attacks on Iran, the BOE had been expected to lower borrowing costs to 3.5% from 3.75%. Its Monetary Policy Committee is now expected to hold, underscoring the difficult choices facing officials. Figures released Friday showed the U.K. economy stalled in January, a development that in less troubled times would prompt the central bank to provide support by lowering borrowing costs.
As with the ECB, policymakers are unlikely to feel in a position to say much that is definitive about the path ahead.
"There are plausible scenarios in which the Middle East conflict prompts the Bank of England to delay interest rate cuts, cancel interest rate cuts or hike interest rates," said Paul Dales, an economist at Capital Economics.
The MPC has been divided between those who favor a faster and those who favor a slower reduction in borrowing costs. Some of the former could vote for another cut, a signal that option has not been removed despite the prospect of higher-than-expected inflation in the near term.
A message of a different sort would be delivered if the MPC removed a phrase that has appeared in recent policy statements to the effect that the key rate is likely to be lowered further.
Switzerland's central bank has fewer immediate challenges to navigate; the country generates much of its electricity from hydro and nuclear power and it is regarded by investors as a safe haven for assets to offset the upheaval unleashed by the Iran conflict and the U.S. administration's trade policy. The Swiss franc has strengthened slightly against the U.S. dollar as a result, while other European currencies have weakened.
"Even in a risk scenario, Switzerland's lower dependence on imported gas and the tendency of the Swiss franc to strengthen in testing times would limit risks to the economy," wrote economists at Lombard Odier in a note to clients. "We think policy rates would remain on hold."
Write to Paul Hannon at paul.hannon@wsj.com
(END) Dow Jones Newswires
03-16-26 0414ET
