By David Barwick – FRANKFURT (Econostream) – European Central Bank Governing Council member Martin Kocher said the central bank was ready to adjust monetary policy quickly and decisively if necessary, as the Middle East war had worsened the inflation outlook and raised the risk of longer-lasting price pressures.

Kocher, who heads the Austrian National Bank, said in a blog post on his institution's website that developments still remained close to the ECB’s baseline scenario, but that the continuing conflict had made the inflation outlook worse.

“It is therefore possible that we will be confronted with longer-lasting inflation,” he said. “At the same time, it is still too early to see a broader increase in prices or second-round effects in the available data.”

The longer energy prices remained high, the more likely such effects would become, he said.

The Governing Council’s decision on Thursday to keep interest rates unchanged gave it time to collect more information and better assess whether the risks were materializing and how they affected inflation and growth, according to Kocher.

The Council was highly vigilant with regard to geopolitical developments and their economic impact, he said.

“The ECB Governing Council is able to act at any time and ready to adjust the monetary policy stance quickly and decisively if this is necessary,” he said, noting that the next Governing Council meeting would take place in mid-June.

The war had fundamentally changed the ECB’s starting position and made monetary policy more difficult, Kocher said.

Before the conflict, monetary policy had been broadly neutral, inflation had fallen rapidly after the surge of 2021 and 2022, and financial markets had even expected further ECB rate cuts, he said.

A strong energy-price increase was difficult for any central bank because such supply shocks had opposing effects, raising inflation while weakening economic activity, he said.

Textbook economics would initially allow monetary policy to look through such shocks, as the weaker economy would damp inflation again over the medium term, he said.

However, such a schematic view could not adequately capture reality, he said.

Should the war last longer, the economy could slide into a downturn, especially if monetary policy reacted too restrictively and amplified the decline, Kocher said.

At the same time, even a shorter-lived shock could cause inflation to rise more strongly than expected and leave prices elevated for longer, he said.

“In this case, it would be best if monetary policy intervened early and decisively with an interest rate increase,” Kocher said.

The last inflation phase had shown how energy shocks could intensify, as higher costs were passed along production chains and companies adjusted prices more frequently in periods of large shocks, he said.

There was also a risk that medium-term inflation expectations would rise, Kocher said.

Companies and workers seeking to avoid losses of purchasing power could demand higher prices or wages, triggering second-round effects that would keep inflation high even after the original energy shock had partly faded, he said.

The current situation differed markedly from 2022, when strong post-pandemic demand, substantial fiscal support, tight labor markets and very loose monetary policy had favored a rapid rise in inflation, he said.

Those conditions were not present today, and the Governing Council therefore saw the risk of an inflation surge comparable to 2022 as lower, Kocher said.

Fiscal cushioning measures should be used very sparingly and, if used, should be temporary and targeted so that fiscal policy did not potentially work against monetary policy, he said.