By David Barwick – FRANKFURT (Econostream) – European Central Bank Governing Council member Joachim Nagel said Friday that the Iran war had sharply raised inflation uncertainty via energy prices and required policymakers to remain “very vigilant,” while judging the Governing Council’s decision a day earlier to leave rates unchanged as appropriate for now.
Nagel, who heads the Deutsche Bundesbank, said the ECB was confronting the new shock “from a position of strength,” with price stability largely restored and policymakers able to act “quickly and in a targeted way” if needed.
Speaking in Goslar, Germany, he said the main risk from the conflict was that surging oil and gas prices could spill over into broader inflation, as had happened after Russia’s invasion of Ukraine. The probability of that, he said, would rise the larger the energy price increase and the longer it lasted.
Rather than reacting mechanically to an energy-driven jump in headline inflation, monetary policy had to focus on whether the shock spread beyond energy and whether inflation expectations drifted higher, he argued. In particular, he pointed to the danger of second-round effects through wages and wider price-setting behavior.
“Monetary policy cannot prevent a short-term rise in inflation as a result of an energy price shock,” he said. “But it must act if second-round effects emerge and longer-term inflation expectations rise above the inflation target, because then high inflation threatens to become entrenched.”
Referring to Thursday’s Governing Council meeting, Nagel said that, “given the Iran war and its effects on inflation, it is necessary to be very vigilant in monetary policy terms.” Because the medium-term consequences for inflation could not yet be assessed reliably, “a wait-and-see stance is appropriate,” he said, adding, “we can react quickly if needed.”
He also stressed that the ECB’s updated staff projections still saw price stability in the baseline over the medium term, even though the inflation forecast for this year had been revised up significantly. At the same time, he said the Iran war created baseline risks of higher inflation and weaker growth.
On the real economy, Nagel said the euro area had so far remained resilient despite external headwinds, though whether it stayed on a moderate growth path would depend above all on how the Middle East conflict evolved. He noted that the staff had therefore complemented the baseline with alternative scenarios examining the effects of longer-lasting high energy prices.
For Germany, Nagel said additional public spending on defense and infrastructure should support growth, while private demand had already been set to recover before the Iran war began. What mattered now, he said, was to follow through on reforms and forward-looking investment so as to put the German economy back on a solid growth path.
