Dr. Kieran McQuinn:

Our outlook on the inflation situation has changed with the events of the last two weeks. Like most commentators, our view on inflation was that it was temporary in nature. The inflationary pressures we witness, particularly the energy market issues we saw and other elements, were down to the energy market and supply chain issues. There were obviously base effects as well which were working through the system in the latter part of last year and into this year. We felt those pressures would abate as we moved through 2022 and that, by the end of this period, the inflation rate would be back at the target ECB rate of approximately 2% across most euro area countries. In that context, we felt that the ECB probably would have been unlikely, certainly in the short term, to increase policy rates. It may do other things such as scale back some of the debt programmes or the support programmes it has, the asset purchasing schemes and so forth, but it was unlikely to increase policy rates.

The events of the last two weeks have potentially changed that considerably. Inflationary pressures are now likely to emerge particularly to do with issues concerning energy but also to do with food, and we have seen the huge pressure in areas such as cereals, grains, wheat and other commodities that originate both in Ukraine and Russia. The upward pressures that are likely to come on price levels from the events of the last two weeks probably are going to be quite significant and, depending on how long the events last, could be quite persistent. In that context the ECB will probably have to look at rates being raised possibly sooner than it would have anticipated. Again, however, it will depend on the overall impact of the crisis on the performance of euro area economies. The ECB will be mindful of the fact that if it starts to increase policy rates, there may begin to be some concerns about sovereign debt sustainability in certain euro area countries, so it might be reluctant to do so. It is a very difficult position for the ECB. On the face of it, substantial increases in inflation, probably like what we are going to witness, would generally be met with higher interest rates and an increase in policy rates, but the implications of the crisis for the growth rates of individual euro area countries and consequently the sustainability of their debt will be an issue as well.