Five questions for the ECB

Yörük Bahçeli and Stefano Rebaudo

LONDON, July 20 (Reuters) – The European Central Bank meets again on Thursday and oil prices are at the top of policymakers’ list of concerns.

The rapid decline in energy prices last month removed immediate pressure on policymakers to raise rates, but the relief proved short-lived; This underscores the uncertainty ahead as a permanent solution to the Iran war appears elusive.

Here are five key questions for markets:

1/ What will the ECB do next Thursday?

It will likely keep its key interest rate at 2.25% following a hike in June, the first among major central banks to raise interest rates in response to the war.

The re-escalation of the war caused oil and natural gas prices to increase. But although oil prices rose above $90 a barrel on Monday, they remain well below peaks in March and April, so policymakers are in no rush to act immediately.

However, as a reflection of the uncertainty, markets are still pricing in the possibility of a small move.

“There will be questions about whether an increase will be discussed in July. I’m pretty sure a few people (policymakers) will be able to raise that issue,” said Jens Eisenschmidt, Morgan Stanley’s chief European economist.

He said this discussion could be a way of signaling the ECB’s current thinking in September.

2/ How does the escalation of the Iran war change the outlook for the European Central Bank?

The rise in oil prices so far has been relatively limited compared to the early stages of the war, meaning the picture has not changed significantly from policymakers’ expectations in June.

The oil futures curve is currently trading between the baseline scenario laid out by Frankfurt and more moderate scenarios, strengthening the possibility of a hold in July.

Eurozone inflation also fell much more than expected in June, and this was not just due to energy prices. Other than these, headline inflation also fell more than expected.

“Policymakers can probably wait until September for more clarity on how developments in the Middle East affect inflation and the inflation outlook,” said Bas van Gaffen, senior macro strategist at Rabobank.

3/ Will the ECB increase interest rates again this year?

Yes, traders and economists polled by Reuters expect new economic forecasts to be released, most likely in September.

Sources told Reuters that even as oil prices fell, the prospect of a rise after July remained solid.

And bullish traders have also increased their bets that there will be an additional move to follow the move in September by the end of the year. However, only three of 74 economists surveyed by Reuters share this expectation.

“Listening to the vast majority of ECB speakers, it is very clear that they are more concerned about a rebound in inflation than the risk of what they see as a still weak but resilient economic outlook,” said Ross Hutchison, head of euro zone market strategy at Zurich Insurance Group.

Fertilizer shortages in the Middle East and a heat wave in Europe could put upward pressure on food prices, driving up inflation even as energy costs fall again.

Still, some analysts are skeptical that the ECB should raise interest rates further at this stage, although so far there is little sign of second-round effects or wage pressures accelerating.

4/ How does the increase in the ECB’s minimum required reserve ratio affect the markets?

Analysts said this would deplete liquidity slightly faster and bring forward slightly the time when money markets will be more responsive to liquidity conditions.

The ECB is considering doubling the proportion of cash that lenders must hold as reserves in a non-refundable account, Reuters recently reported; This will reduce the interest it has to pay banks on excess reserves, which increases as interest rates rise.

Societe Generale expects any impact on short-term financing markets to be modest.

This measure will reduce the amount of excess liquidity in the system by approximately 160-170 billion euros, compared to the approximately 500 billion euros per year that quantitative tightening has already withdrawn from the system.

5/ Is the digital euro finally gaining traction?

Yes. The ECB won significant parliamentary support for the project in June after three years of wrangling with banks fearing an outflow of deposits and loss of income.

The launch of a digital euro has become more urgent for Frankfurt as President Donald Trump’s tariffs raise fears that the United States could one day weaponize its dominance over US payment networks.

The goal is for negotiations to produce a final law by the end of the year. A pilot program will begin next year, followed by a launch in 2029.

Morgan Stanley’s Eisenschmidt said the digital euro is a good starting point for reducing dependence on foreign payment networks, but the focus on retail users so far in its design would limit that goal.

(Reporting by Yörük Bahçeli and Stefano Rebaudo; editing by Amanda Cooper and Ros Russell)