ECB Hikes Held Back by Hormuz Tensions

The European Central Bank (ECB) is at a crossroads as it navigates the current energy price shock and its potential impact on inflation. According to ECB-watchers, the key factor will be the situation in the Middle East, particularly the Strait of Hormuz, which has become a swing factor for the ECB's future decision-making.

The ECB is concerned that a prolonged disruption in the Strait of Hormuz could turn an energy-price shock into a broader inflation problem. While a central bank can look through a temporary energy shock, it cannot afford to look through a persistent one.

With euro area headline inflation rising to 3.3% year-on-year last month and core inflation easing to 2.4%, the ECB has a delicate balance to strike. A prolonged disruption in oil and gas prices could lead to second-round effects, making it harder for the ECB to keep inflation expectations anchored.

If energy markets settle down, the ECB may be able to pause and assess the damage, but if tensions continue to rise, the balance of risks changes rapidly. Traders are already pricing nearly three further 25bp hikes beyond today by the end of next year.