• Longer war increases likelihood of second-round effects
• I don’t see second-round effects yet
• The balance of risks has clearly deteriorated

ECB’s Elderson warned that a prolonged conflict in the Middle East increases the risk that today’s energy-driven inflation shock evolves into broader and more persistent price pressures, reinforcing expectations that the ECB will raise interest rates at its June meeting.

Elderson said that a longer war would increase the likelihood of so-called “second-round effects”, a scenario in which higher energy costs spread into wages, services, and other parts of the economy. However, he stressed that he is not seeing clear evidence that such effects have materialized yet.

His remarks underscore the ECB’s central dilemma as policymakers prepare for a 25 bps rate hike next week. The euro area’s inflation rate accelerated to 3.2% in May, while core inflation rose to 2.5%, suggesting that price pressures remain stronger than the ECB’s 2% target despite weakening economic activity. Markets overwhelmingly expect a June rate hike, with at least another one coming before year-end.

The backdrop remains dominated by the US-Iran conflict and continuing disruptions to energy markets. Oil prices have remained significantly above pre-war levels as uncertainty persists around shipping through the Strait of Hormuz. ECB officials increasingly fear that if elevated energy prices persist for several quarters, businesses could begin passing higher costs onto consumers while workers seek compensation through stronger wage demands.

Recent Governing Council discussions acknowledged that the current situation differs from the 2022 energy shock because inflation expectations remain relatively anchored, demand is weaker, and labor-market pressures are less intense. Nevertheless, policymakers have repeatedly warned that the risk of second-round effects rises substantially if the conflict drags on and energy prices remain elevated.

For policymakers, the key concern is credibility. Many ECB officials argue that waiting until second-round effects appear would risk repeating the mistakes of past inflation cycles. As a result, the expected June rate increase is increasingly being viewed as a pre-emptive move designed to prevent temporary energy-driven inflation from becoming entrenched in the broader economy.