ECB Governing Council member Gabriel Makhlouf said Friday that the risks to euro-area inflation have shifted upward. The reason is the same one tripping up every other major central bank: the Middle East and what it is doing to energy prices.
His comments dropped one day after the ECB held rates steady.
Makhlouf, who also runs Ireland's central bank, said upside risks to inflation have intensified since the Iran war began moving energy markets. He said he is worried that prices stay high longer than markets expect, since there is no clear timeline for the conflict to end.
He flagged two channels he is watching closely.
The first is what economists call indirect effects. That is when expensive energy pushes up the cost of producing, transporting, and selling everything else, and Makhlouf said those costs are already getting passed through.
The second channel is wages. Makhlouf said second-round effects through pay rises will take longer to show up in Europe than in the U.S., because European wages get reset on a staggered schedule across industries.
That delay can be a problem. By the time the data shows up, the inflation it is feeding is already in the system.
He also said inflation expectations need close watching for any sign they are coming unanchored. Why? Once people start expecting higher inflation, they often act in ways - asking for raises, raising prices early - that make it real.
The ECB kept its deposit rate at 2% on April 30 for the third consecutive meeting. The Governing Council also said upside risks to inflation and downside risks to growth have both intensified - the same balance the Bank of England flagged the same day.
Euro-area flash inflation jumped to 3% in April, driven largely by energy. Markets are starting to price in the possibility the ECB lifts rates back up later this year if the energy shock keeps grinding through European economies. Some traders see the deposit rate moving toward 2.5% by year-end.
That would mean the era of European rate cuts is over, at least for now.
A higher ECB deposit rate strengthens the euro against the dollar, which can pressure U.S. multinational earnings reported in dollars. It also lifts borrowing costs for European companies.
European bank stocks like BNP Paribas, Deutsche Bank (DB), and Banco Santander (SAN) tend to move higher on hawkish ECB shifts. The opposite is true for European auto and luxury exporters.
Makhlouf gave no signal on his own next vote. The next ECB rate decision lands in June, and traders will be watching whether more council members start sounding like Makhlouf between now and then. Inflation data for the euro area is due before that meeting.
