ECB officials warn high oil prices could force further interest rate hikes

Why the ECB is hinting at more hikes

The European Central Bank is signalling that its campaign to cool prices is far from finished, with policymakers warning that a fresh energy shock could force borrowing costs even higher.

Just a day after the central bank raised its benchmark interest rate by a quarter-point to 2.5%, officials acknowledged that investors are entirely justified in betting on further increases. With global oil prices climbing back above $100 a barrel, those investors are now pricing in three additional hikes in the coming months.

Ulo Kaasik, the joint governor of Estonia's central bank and a member of the ECB's Governing Council, said the financial market's anticipation of a longer tightening cycle makes perfect sense.

"It’s true the markets are expecting the interest-rate hiking cycle to continue, and looking at the current developments it’s understandable why the markets think that," Kaasik told Estonian newspaper Aripaev. He added that the current 2.5% rate is not yet particularly restrictive, describing it as a level that "should not yet perhaps directly tighten economic activity too much."

Energy shocks drag out the inflation fight

The central bank's latest rate rise was its second since the outbreak of the war in the Middle East, a conflict that has once again unsettled energy markets. Eurozone inflation is currently hovering around 3%, comfortably above the ECB’s official target of 2%.

ECB President Christine Lagarde has warned that the current inflation shock is proving to be deeper and more durable than previous spikes. That assessment was echoed by Lithuanian central bank governor Gediminas Simkus, who told national broadcaster LRT that energy remains the primary driver of the region's price pressures.

"Inflation is too high both in the euro zone and in Lithuania," Simkus said. While he declined to speculate on what the Governing Council might decide at its next meeting, he had previously warned that Thursday's quarter-point increase would not be enough to bring inflation back down to the 2% target over the medium term.

According to Simkus, the persistence of the shock is now the main concern. "What matters isn’t just the current rate of inflation, but also how long it might remain at such a high level," he said.

What comes next for interest rates?

With energy markets highly sensitive to geopolitical tensions, another interest rate increase could arrive as early as next month.

Central bankers are walking a difficult line. They must convince households and businesses that they are serious about crushing inflation, without raising rates so fast that they trigger a severe recession.

For now, the message from Frankfurt is clear: the current level of interest rates is not the ceiling. If oil prices remain stubborn, borrowing costs will have to go higher still.