The ECB’s dilemma in the face of the energy crisis - March 16, 2026

With stock markets down 10% and long-term interest rates on the rise, domestic financial conditions in Europe have deteriorated. The ECB’s stance – its next meeting is scheduled for 19 March – will be closely scrutinised.

Stagflationary shocks are particularly unpleasant. They lead to downward revisions in growth forecasts but upward revisions in inflation, which complicates the task for central banks. The most recent example prior to the crisis in Iran was the US tariffs of 2025, which led the US Federal Reserve to halt its rate-cutting cycle during the first nine months of the year, even as the labour market was weakening (Chart 1). At the end of those nine months, it concluded that, despite inflation remaining above the 2% target, overall inflationary pressures remained sufficiently contained to cautiously resume the path towards interest rate normalisation. Among these indicators, the labour market, rent prices, inflation in services, wage pressures and medium-term inflation expectations all pointed to a moderation in inflationary risks.

Will the ECB follow the same ‘wait-and-see’ approach in the face of the Iranian shock? The starting point is different: European inflation and ECB rates have been stabilised at 2% for several quarters now. Furthermore, the ECB’s mandate focuses solely on inflation, and not on employment as well, unlike the Fed. This single mandate creates a bullish bias among investors whenever inflation threatens to rise again. And this is precisely what we are seeing: whilst markets were pricing in a 50% probability of an ECB rate cut in 2026 just before the attack on Iran, they now anticipate between one and two ECB rate hikes this year (Chart 2).

Among the factors that could argue in favour of a rate hike are the recent fall in the euro, the persistence of inflation that is slightly too high and resilient in the services sector (just over 3%, twice the pre-Covid level), and of course the fear of second-round effects following the rise in energy prices.

On this last point, econometric models generally incorporate a principle of non-linearity: up to a certain point (in terms of magnitude and duration), commodity price shocks generally have little effect on ‘core’ inflation, i.e. excluding food and energy. But once a certain threshold is crossed, the spillover from the price shock becomes significantly greater. Goldman Sachs experts estimate, for example, that a one-month closure of the Strait of Hormuz (with oil prices between $100 and $130) would push up core inflation by just 0.1% in the eurozone. In a scenario where the closure lasts two months with the price per barrel rising to $150, the impact would, however, be 0.8%, resulting in core inflation of 3% (Figure 3).

In all these scenarios, however, a surge in inflation akin to that of 2022 seems unlikely. Even with 3% core inflation, raising rates would not necessarily be a good idea for the ECB, particularly if unemployment were to rise rapidly at that point.

The experiences of 2008 and 2011, when the ECB made the mistake of raising interest rates in the face of a temporary spike in inflation in the midst of the financial crisis, are still fresh in everyone’s memory. However, the pressure is likely to be intense, as the ECB and other central banks were conversely accused of underestimating the inflationary risk following the Covid crisis in 2021 and 2022. The current situation is, however, completely different today, with wage pressures in particular slowing down (Chart 4).

In this delicate phase for the European economy, the ECB will therefore need to tread carefully. All the more so because, unlike the Fed, it must also gauge the impact of its decisions on all national interest rate markets. Having converged significantly over several quarters, long-term rates have experienced a divergence shock since the start of the conflict (Chart 5). There is no immediate danger yet, but the ECB cannot completely ignore these developments.

Discussions within the ECB are therefore likely to be lively. The next meeting is on 19 March, the same day as a major European summit. Pending these events, and given the duration of the crisis in Iran, we have slightly reduced our exposure to equity markets. We remain invested, however, and stand ready to increase our exposure again should the energy crisis take a less negative turn.