Several policymakers at the European Central Bank are cautious about implementing a rate increase during the April meeting because they have not seen firm proof that the recent energy-related jump in inflation is becoming broad-based or entrenched, four sources familiar with policy discussions said.
Those close to the deliberations stress that second-round inflation effects remain possible and that tightening policy is still an available option. But they say policymakers want to see clearer, tangible indicators before deciding to raise rates.
Inflation rose to 2.5% in March from 1.9% a month earlier, a move market participants attribute in part to higher energy prices after the outbreak of conflict in the Middle East. Policymakers are debating whether a pre-emptive rate increase is necessary to prevent longer-term inflation expectations from drifting upward.
"Longer term inflation expectations have not increased, domestic inflation is slowing and the jump in petrol prices is hitting disposable incomes, which actually limits companies' ability to raise prices," one of the sources, who asked not to be named, said. The same source added: "I can’t tell you what we’re doing on April 30 but I can tell you that as of today, I don’t have evidence to support a hike."
An ECB spokesperson declined to comment.
Sources also pointed to relatively soft labour markets, which they said reduce workers' scope to press for higher wages. That dynamic, in the view of those officials, acts as a moderating force on inflationary pressures for now.
ECB President Christine Lagarde on Tuesday described recent economic developments as sitting between the bank's baseline and an adverse scenario. Market participants interpreted those remarks as an indication that a rate rise is not imminent.
Investors currently put only about a one-in-five probability on a rate hike in April, but pricing in markets signals a full likelihood of a move by June, followed by another increase in the autumn, according to the sources' description of market expectations.
Some policymakers warn there could be costs to waiting too long. "Sooner or later a credibility problem is going to come up," a second source said. "If we keep getting high inflation numbers and the world just sees the ECB sitting and doing nothing, they could start doubting our commitment. That credibility concern could get large enough to force action."
The sources also cautioned that even if the conflict in Iran were to be resolved quickly, energy markets would likely take many months to return to normal. That persistence increases the possibility that businesses will begin adjusting their prices on the assumption that elevated energy costs will last, the sources said.
They added that the so-called memory effect of having experienced high inflation only four years ago could make firms more prone to quicker price adjustments, which in turn raises the risk of a self-reinforcing inflationary cycle.
Context and implications
Policymakers are balancing the current absence of broad-based domestic price pressures and soft labour markets against the risks that a sustained energy shock and shifting expectations could prompt faster wage and price adjustments. For now, officials say they need clearer evidence that inflation is moving beyond energy-driven spikes before committing to policy tightening.