These rate adjustments are expected to have a limited impact on financial markets, as they have already been largely priced in. The markets were quick to anticipate this monetary tightening following comments from central bankers who indicated they were ready to act. Consequently, financial conditions have already tightened, reducing the element of surprise and the potential impact of future rate rises.
In the wake of rising oil prices following the conflict in the Middle East, economic indicators have deteriorated in the eurozone. Consumer confidence has weakened significantly and consumer credit applications have slowed. On the corporate side, many companies are reporting rising input costs, whilst business activity is slowing, particularly in the services sector. The latest economic statistics have tended to fall short of consensus expectations in the eurozone, a trend that contrasts with that observed in the United States, where economic data has ultimately been close to expectations. For the time being, the markets have focused on the impact of the conflict in the Middle East on inflation. But if oil prices remain at these levels, the risks to economic growth will become hard to ignore...
The risk of a shortage of oil products and derivatives increases with every day that the Strait of Hormuz remains closed. In the absence of an alternative solution, only an automatic fall in demand could resolve such a shortage. As oil stocks dwindle dangerously, we are moving closer to this scenario: price rises could therefore well turn into a shortage of finished products. It goes without saying that the ECB, through its monetary policy, cannot address this type of supply-side issue. Whilst rate rises may curb domestic inflationary pressures in the event of strong domestic demand, central banks have no control over oil supply or the Strait of Hormuz. Such a stance by the ECB risks even exacerbating the slowdown in domestic demand, which is already under pressure from oil price inflation – which is primarily what is known as imported inflation.
In most developed countries, growth in real household incomes is now outpaced by inflation, meaning that households’ purchasing power is declining. Rather than preparing the markets for rate rises, the ECB might have been better off exercising discretion and intervening only if inflation expectations became incompatible with its mandate, which has never really been the case. Such an approach would probably have kept interest rates lower than current levels across the entire yield curve.
The bond markets, which have priced in several interest rate rises, are beginning to offer attractive yields at the short and medium end of the curve. If the ECB takes monetary tightening too far, the market could subsequently view its actions as a monetary policy error. In this scenario, an inversion of the yield curve – characterised by short-term rates exceeding long-term rates – cannot be ruled out.
