Rehn: Geopolitics clouds euro area growth, inflation outlook

Geopolitics now affects every dimension of the economy, including growth, inflation, and financial stability, according to Governor Rehn.

The Middle East conflict is an "acute blow" to the global economy, causing collateral damage to both Asia and Europe.

For the euro area, the war in Iran represents a negative terms-of-trade shock, which will increase inflation and weaken growth this year.

The medium-term effects remain uncertain, a crucial factor for the European Central Bank's monetary policy, which is guided by a medium-term orientation and a symmetric 2 percent inflation target.

The ECB's key interest rate currently stands steady at 2.0 percent.

Rehn emphasized that the persistence of the shock, rather than immediate price increases, is what matters most for policymaking, necessitating a strong focus on incoming data and continuous scenario analysis.

The euro area has extensive experience dealing with various shocks and inflation drivers, but "crises are not twin sisters," Rehn noted.

Geopolitical shocks are complex, multi-channel events that not only raise oil prices but also increase uncertainty, tighten financial conditions, and disrupt international trade, thereby dampening growth.

Rehn referenced the 2022 energy shock following Russia's invasion of Ukraine, which saw inflation peak above 10 percent.

The ECB responded by tightening monetary policy, successfully stabilizing inflation back to 2 percent without triggering a recession or mass unemployment.

This contrasts with the 2011-2014 oil price spike, where limited pass-through to underlying inflation, due to the euro area debt crisis, led to reversed rate hikes.

The inflationary impact of an energy shock depends on the broader macroeconomic environment, including demand, supply, and expectations, underscoring the need to monitor second-round effects and inflation expectations closely.