A senior European Central Bank policymaker has cautioned that the institution must brace for a potentially prolonged Middle Eastern conflict, warning that such a scenario could keep eurozone inflation elevated for an extended period.
Finnish central bank chief Olli Rehn stated that officials cannot afford to be complacent regarding these inflationary pressures, specifically pointing to the near-closure of the Strait of Hormuz shipping lane and the conflict's impact on energy prices. He emphasized the unacceptability of an affordability crisis emerging in Europe.
Rehn's comments arrived ahead of data expected to show eurozone inflation climbing to 3.3% in August, up from 2.9% in July, driven by elevated oil and gas prices stemming from Middle East tensions. Since March, inflation has consistently exceeded the ECB's 2% medium-term objective.
These remarks signal a notable hawkish shift from Rehn, who had previously placed greater emphasis on risks to economic growth rather than inflation. His stance indicates broadening support within the ECB's Governing Council for tighter monetary policy.
Isabel Schnabel, an ECB executive board member and prominent hawk, publicly advocated for another rate increase in September during a recent interview. In June, the ECB raised its benchmark rate by 25 basis points to 2.25%, becoming the first G7 central bank to hike borrowing costs in response to the Middle East energy shock.
Market pricing suggests a greater than 95% probability of a 25-basis-point hike at next week's Governing Council meeting in Berlin, which would lift the deposit rate to its highest level since March 2025. Investors have also fully priced in an additional 25-basis-point increase, anticipating the deposit rate to reach 2.75% by February.
While Rehn did not explicitly endorse a September move, he described market expectations for the upcoming meeting as understandable. He adopted a more cautious tone regarding subsequent decisions, emphasizing the need for meeting-by-meeting assessments given the broad geopolitical uncertainties.
Hopes for a swift resolution to the Middle East conflict and the restoration of normal shipping through the Strait of Hormuz faded over the summer as temporary ceasefire negotiations collapsed. Over the weekend, US forces struck an Iranian rocket launcher on an island in the strait, marking the first American attack on Iranian forces in over a month.
Tehran responded by launching missiles toward Jordan. Oil prices have since climbed back above $90 per barrel, up 13% from early August and roughly a quarter higher than pre-conflict levels from late February.
Rehn warned of the necessity to prepare for a drawn-out confrontation, citing the fundamentally conflicting objectives between the Trump administration and Iran's Revolutionary Guard, which could lead to a war of attrition in the region.
Despite these challenges, Rehn noted that eurozone economic growth has shown remarkable resilience this year, performing better than anticipated amid rising energy costs and trade tensions. Based on recent data, he indicated that Finland's central bank would likely upgrade its 2026 growth forecast from the current 0.7%.
He now projects annual growth of roughly 1.5% to 2%, describing Finland's economy as a microcosm of the eurozone, heavily reliant on Germany's export engine. Economists suggest Germany, the eurozone's largest economy, is on track for its strongest growth since 2022.
While higher energy prices are driving headline inflation, Rehn stated there are currently no signs of second-round effects, such as wage-price spirals. However, he noted that inflationary surges following the pandemic and Russia's full-scale invasion of Ukraine were not initially reflected in economic forecasts, explaining why the Governing Council remains cautious in its assessments and maintains critical scrutiny of all projections.