Bank of France Governor Francois Villeroy de Galhau has told CNBC that the European Central Bank “will do what is necessary” to keep inflation on target.
Speaking to CNBC’s Lisa Kim in Singapore, Villeroy de Galhau sought to reassure sovereign debt markets that European central bankers were committed to minimising the impact of the Iran war.
Spiking oil prices, driven by the effective closure of the Strait of Hormuz, have fuelled concerns that an energy crisis could trigger a resurgence of inflation across various markets.
Villeroy de Galhau, a member of the ECB’s Governing Council, stated that European policymakers “will do what is necessary as an independent central bank to bring inflation back to target.”
“If I speak on behalf of the ECB, this means do what is necessary to bring inflation back to 2% in the medium term. Markets can be assured of that,” he told CNBC.
Eurozone inflation had dipped below the ECB’s 2% target to 1.9% before joint US and Israeli strikes on Iran on February 28 triggered the Middle East conflict.
Inflation in the eurozone subsequently jumped to 3% in April, rising sharply from 2.6% in March, as the economic effects of the war took hold.
Europe faces particular vulnerability to energy shocks given its status as a major net energy importer, with fuel prices surging and some governments already intervening in domestic markets.
“The effect of the Middle East conflict is clear,” Villeroy de Galhau said. “In the short run, there are significant upward pressure first round effects due to energy prices, but it’s our responsibility, I would even say our commitment to prevent second round effects.”
Germany’s 10-year bund has surged by around 32 basis points since the war began, with other eurozone bonds experiencing even larger swings as investors priced in higher inflation and tighter monetary policy.
Villeroy de Galhau explained that the ECB held its key interest rate steady at 2% last month because officials lacked sufficient data on the risk of second-round inflation effects, including underlying inflation figures, inflation expectations, and wage growth data.
“The data so far are telling that it’s mainly a first-round effect, but we should be extremely vigilant about possible second-round effect,” he said. “So, again, have no doubt we will act as much as necessary.”
Markets are overwhelmingly pricing in a rate hike at the ECB’s June meeting, according to LSEG data, with most traders anticipating a rise of at least 50 basis points by the end of the year.
ECB President Christine Lagarde said at the end of March that the central bank was prepared to raise interest rates even if an expected rise in inflation proved temporary.
“To leave such an overshoot entirely unaddressed could pose a communication risk: the public may find it difficult to understand a reaction function that does not react,” Lagarde told a conference in Frankfurt.
Bundesbank President Joachim Nagel, speaking at the IMF’s Spring Meeting in Washington last month, said oil price volatility had left the ECB “between our baseline and our adverse scenario.”
Martins Kazaks, governor of Latvia’s central bank and a fellow ECB Governing Council member, has also warned of a potential “layer cake” of economic shocks facing the eurozone.