ECB: "Inflation to Remain Well Above 2% Until Mid-2027"

The European Central Bank warns that rising energy prices will continue to impact until 2027. As stated in the Economic Bulletin released this morning: "The conflict in the Middle East and recent developments in Russia's unjustified war against Ukraine have further increased energy price pressures," they write from Frankfurt, indicating it is "likely" that this will "keep overall inflation well above the target (2%) until the first half of 2027."

"Afterwards," the ECB continues, "the energy component is expected to decline and remain negative until mid-2028, leading to a decrease in overall inflation." The institution also anticipates "that energy price hikes will gradually affect food and core components." According to the ECB, "improved economic prospects should also contribute to a slight rise in core inflation, which would continue to grow until early 2027 and remain high for the rest of the year, then decrease in 2028." Overall, "it is expected that overall inflation will return to around the target by the end of 2027, supported by the effects of higher interest rates."

The Frankfurt-based bank believes that the risks to inflation outlook are "tilted to the upside," mainly due to the Middle East conflict and developments in Russia's war against Ukraine. The energy crisis could still worsen, significantly driving up other prices. In particular, gas prices could rise if there are further supply disruptions or a harsh winter coincides with low energy stock levels. This scenario could lead to a probable increase in inflation through indirect and secondary effects.

Moreover, new trade tensions could lead to greater fragmentation of global supply chains, reducing the availability of critical raw materials and exacerbating capacity constraints in the euro area economy. Added to this are extreme weather events and the broader unfolding of the climate and environmental crisis, which could drive up food prices. 

Conversely, inflation could be lower if current geopolitical conflicts are resolved sustainably, or if the indirect or secondary effects from the recent energy price shock prove less pronounced than anticipated. Additionally, more volatile and risk-averse financial markets could weigh on demand, further reducing inflation.

The governing council will therefore "continue to closely monitor the magnitude and persistence of energy price increases, as well as how these are transmitted to price and wage formation, inflation expectations, and overall economic dynamics."