Qatar National Bank (QNB) suggested that the need to continue tightening monetary policy on the part of the European Central Bank has declined, in light of the receding risk of the energy price shock transmitting to inflation, the weak growth expectations in the euro area, and the shift in the rhetoric of central bank officials towards anticipation and evaluation of data before taking any new steps regarding interest rates.
The bank explained in its weekly report that if a new inflationary shock does not occur, or basic price pressures continue for a longer period than expected, the increase in interest rates last June will likely represent the end of the European Central Bank’s monetary tightening cycle, with the possibility that basic interest rates will remain unchanged during the remainder of the year.
The report stated that the European Central Bank had been moving since the beginning of the year to keep interest rates unchanged throughout 2026, based on the success of the process of reducing inflation, as the inflation rate fell to a level close to the 2 percent target by the bank, while the interest rate on deposits reached 2 percent, a level that is widely considered neutral.
The bank considered that the escalation between the United States and Iran changed these expectations suddenly, as severe disruptions in supplies and restrictions imposed on shipping movement through the Strait of Hormuz led to a sharp rise in oil and natural gas prices, which pushed inflation again to a level exceeding the target rate.
The report pointed out that policymakers are becoming increasingly concerned about the possibility of the impact of rising energy costs being transmitted to the prices of other goods and services, contributing to inflation remaining high for a long period through secondary effects.
He pointed out that the euro zone was greatly affected by the rise in natural gas prices, as gas not only constitutes a large share of its energy imports, but is also a major factor in determining prices in electricity markets.
In light of these risks, the European Central Bank raised its deposit rate by 25 basis points last June, to prevent what was initially seen as a temporary shock in the energy sector from turning into a broader inflationary problem.
The report found that monetary policy has so far succeeded in containing these effects, unless there is an additional and significant rise in energy prices for a long period.
The bank discussed three main factors that support this assessment, the first of which is the decline in inflation risks that prompted the European Central Bank to raise interest rates last June.
He noted that recent inflation data showed the limited transmission of rising energy costs to the economy, despite the continued escalation between the United States and Iran.
He pointed out that total and core inflation last June came below expectations, while wage growth continued to be moderate, which limited the risk of transmission of rising energy costs to the rest of the components of the economy.
Qatar National Bank indicated in its report that euro inflation swap rates, a market-based measure of investors’ inflation expectations, fell below the European Central Bank’s target rate of 2 percent over the next year.
He considered that these developments reinforce expectations that the inflation shock will be temporary, which greatly weakens the justifications for continuing to tighten monetary policy.
Regarding the second factor, the bank believed that the weak growth expectations in the euro area in turn strengthened the justifications for not making further increases in basic interest rates, as business activity remained weak, with the composite purchasing managers’ index, which combines the manufacturing and services sectors, remaining below the level of 50 points, the separator between expansion and contraction, during the past three months.
He pointed out that the continued weakness of economic activity prompted analysts to lower their growth expectations, as the agreed-upon expectations for real GDP growth during the current year declined from 1.2 percent before the start of the escalation between the United States and Iran to 0.6 percent.
The report also suggested that the slowdown in economic growth would reduce underlying inflationary pressures by weakening demand in the economy as a whole.
In light of these facts, any additional monetary tightening may entail the risk of unjustified pressure on an already fragile economy.
The third factor is related to the position of monetary policy makers, as recent data and statements issued by the European Central Bank indicate their increasing comfort with the idea of keeping interest rates unchanged.
The report stated that the bank’s Board of Governors confirmed, during its meeting last June, the continuation of a data-driven approach, while evaluating economic developments at each meeting separately, without committing in advance to a specific path for basic interest rates.
He pointed out that this trend was reinforced during the European Central Bank’s annual forum on central banking affairs, which was held in the Portuguese city of Sintra, with the participation of central bank governors, academics and participants in financial markets to discuss the prospects for the global economy and the challenges facing monetary policy.
The report highlighted the indication by Christine Lagarde, President of the European Central Bank, during the forum, that the risks associated with inflation and growth have generally become more balanced, while other members of the Board of Governors indicated the appropriateness of following a wait-and-see approach.
Some Council members also expressed their willingness to keep key interest rates unchanged, provided that incoming data continue to confirm a decline in inflation risks.
In light of these statements, the report concluded that the Board of Governors has become increasingly focused on evaluating incoming economic data and inflation and growth developments, rather than preparing for a new and imminent increase in policy interest rates.