Middle East war shifts inflation, tightens policy expectations

Ms. Schnabel reported a sharp shift in financial markets following the Middle East war, marked by surging energy prices and increased volatility.

Brent crude oil prices exceeded USD 100 per barrel, triggering sell-offs in risk assets and bonds.

Unlike previous geopolitical shocks, markets now predominantly priced in the inflationary effects of the conflict, necessitating tighter monetary policy.

Near-term inflation compensation in the euro area rose significantly, with inflation-linked swap forward rates surpassing 2% across horizons, though longer-term compensation remained stable.

This reflected both higher genuine inflation expectations and increased inflation risk premia.

The balance of risks to the inflation outlook shifted sharply to the upside for shorter horizons.

Nominal rates in both the euro area and the United States increased, driven by higher short-term rate expectations and term premia, signaling greater uncertainty and anticipated monetary tightening.

Mr. Lane outlined the war's impact, creating upside inflation risks and downside output risks.

Euro area headline inflation rose to 1.9% in February, with core inflation at 2.4%.

Wage growth decelerated to 3.7% in Q4 2025, though the energy shock still posed second-round effect risks.

The March ECB staff projections, updated to March 11, revised headline inflation upwards for 2026 (2.6%), 2027 (2.0%), and 2028 (2.1%), driven by higher energy prices.

Core inflation also saw upward revisions.

Near-term market and survey-based inflation expectations increased, but medium-term expectations stabilized at the 2% target.