ECB sees persistent inflation from energy shock

ECB Executive Board member Isabel Schnabel noted that euro area financial markets continue to be driven by Middle East developments and their impact on energy prices.

Markets expect the oil price shock to be persistent, leading to a notable and sustained inflationary impact.

Inflation fixings have increased further for both 2026 and 2027, suggesting investors anticipate indirect or second-round effects extending beyond the first year of the conflict.

Despite negative macroeconomic data for the euro area, risk asset markets are buoyant, hovering near all-time highs.

This might indicate some investor complacency given the size and persistence of the energy price shock.

Investors are pricing in cumulative policy rate hikes by the ECB of 73 basis points in 2026, reflecting inflation as the dominant risk.

Overall, financial conditions have eased since the previous meeting, mainly due to strong risk asset markets, but remain somewhat tighter than before the war.

The divergence between interest rate markets and riskier asset classes stems from investors' assessment of the energy shock's impact on inflation and growth.

Inflation expectations have shifted higher for the euro area for 2026 and 2027, while growth expectations show only a modest adjustment.

Euro area and US growth projections have edged down, but without pointing to a pronounced slowdown.

The EUR/USD exchange rate has rebounded to near pre-war levels, supported by improved global risk sentiment and expectations of tighter ECB monetary policy relative to the US.

Equity markets appear to be largely looking through the energy price shock, with euro area sovereign bond spreads also narrowing.

Ms Schnabel also touched upon the rise of tokenised financial markets, noting their rapid expansion and potential for efficiency gains, while highlighting liquidity fragmentation as a key central bank concern.