By David Barwick – FRANKFURT (Econostream) – European Central Bank Executive Board member Philip Lane said Tuesday that a June interest rate increase, if decided, would not necessarily imply the start of a full tightening cycle.

Lane told Nikkei that the ECB was still assessing the size of the Middle East energy shock and would not pre-commit to a particular policy path.

“In a world of uncertainty, we do not pre-commit,” he said.

Lane laid out three possible policy responses to the shock.

If the energy supply shock were small and temporary, the ECB could look through it, he said.

If the shock were persistent but medium-sized, some interest rate response might be appropriate, but this would be limited, Lane said.

“Third, if the shock becomes large and broadens out in a non-linear way, then a stronger monetary policy response would be needed,” he said.

Asked which scenario was closest to the current situation, Lane said the Governing Council was still judging the size of the shock.

“The longer the conflict continues, the less likely the most benign scenario – where it is just a temporary spike in energy prices – becomes,” he said.

Oil prices were likely to remain elevated for longer than assumed in the ECB’s March projections, Lane said.

He also said market pricing of future ECB rates was sensitive to oil prices and did not require additional ECB signaling.

“They see the same shock that we see,” he said. “I don’t think the market needs some kind of extra guidance from us.”

If the ECB raised rates in June, later decisions would still depend on incoming data, Lane said.

“I don’t think we need a complete vision for the future by June, because the vision for the future will depend on the incoming data,” he said.

Decisions in July, September and beyond would be data-dependent, he said.

“We do not pre-commit to a particular path for policy rates,” Lane said. “Essentially, we’ll still be debating those options.”

Lane said the macroeconomic outlook had worsened because of the Iran war.

Uncertainty had increased, and higher energy prices were weighing on consumption and investment in Europe, he said.

Because the Eurozone was a large net energy importer, higher energy costs were an important drag on activity, Lane said.

“A prolonged conflict in the Middle East could lead to a more prolonged period of economic weakness,” he said.

Some of the downside had already been included in the March forecast, but the ECB would decide in June whether further revisions were needed, Lane said.

The inflation outlook had also worsened, he said.

Oil prices had exceeded the assumptions in the March projections, while gas prices had been less affected, partly because of expected additional supply from the United States, Lane said.

“On net, I still think that there has been upward pressure on inflation,” he said. “We are likely to make a further upward adjustment to the inflation forecast in June.”

Lane said the ECB expected indirect effects beyond energy prices.

Firm surveys suggested that many companies expected to raise prices, he said.

“If this develops from an energy shock into a broader inflation problem, that would be a major issue,” Lane said.

How quickly the war was resolved would be important, he said.

If the conflict persisted, the outcome would depend on the size of the direct price effects and the damage to the world economy, Lane said.

Airlines had already raised prices because of fuel costs, but some were now reversing increases as demand weakened, he said.

“The question is, are they limited or do they become more significant?” Lane said. “We’re still in monitoring mode.”

Lane said the current situation differed from the 2022 inflation shock because demand conditions were weaker and the starting point for monetary policy was different.

In 2022, Europe was reopening after the pandemic, with strong demand in tourism and services, while the ECB was moving from negative rates toward restriction, he said.

“This time, we entered the shock in a broadly neutral position, with policy rates around 2% and inflation around 2%,” he said.

Lane also said Germany’s automotive sector had been adjusting for years, while stronger domestic demand and new EU trade agreements could help diversify export markets.

Germany’s shift in fiscal policy, partly linked to defense spending, was already supporting firms competing for orders, he said.

“What we see now is the direct effect on many firms that are competing to fill orders from German defence spending, which is a boost to the European economy,” he said.

Lane said EU bond markets had remained fairly stable despite higher long-term yields in some countries.

Term premia had increased gradually, but this was a global development, he said.

The EU fiscal framework remained an anchor because member states had to comply with jointly agreed fiscal targets and plans, Lane said.

Lane also called for deeper European capital markets.

A larger pool of euro-denominated assets would make Europe more attractive for global investors, including in Asia, he said.

“If there is sufficient consensus to issue more euro-denominated bonds, that would be very attractive for global investors and it would strengthen the international role of the euro and enhance Europe’s position as a safe haven,” Lane said.