March ECB meeting: Well-positioned to navigate the uncertainty

As expected, the European Central Bank (ECB) held policy rates steady today, extending its pause for a sixth straight meeting in the current easing cycle. Rates on the deposit facility, main refinancing operations, and the marginal lending facility remain at 2.00%, 2.15%, and 2.40%, respectively.

The conflict in the Middle East has not only made the outlook more uncertain, but it has created both upside risks to inflation and downside risks for growth. Following the meeting and despite ECB President Christine Lagarde’s measured assessment of the situation, markets are now pricing in two 25bps hikes this year, including a hike as soon as next month. The ECB provided new economic forecasts, which included alternative scenarios that incorporated a more persistent rise in energy prices.

Growth: Economic conditions have shown resilience over recent quarters. Strong domestic demand was fueled by solid private consumption growth and investment, underpinning activity. Yet, this is buffeted by a very difficult external environment, with the Iran war disrupting commodity markets, income, and confidence. Indeed, Lagarde noted that amid these notable crosscurrents, risks to growth are tilted to the downside.

Inflation: Indicators of underlying inflation have been little changed in recent months and remain consistent with the ECB’s target. The increase in energy prices will drive inflation in the near-term, with the duration and intensity of the conflict driving any direct and second-round effects to prices. Unlike during the 2022 energy shock, Lagarde noted that the ECB today is much better positioned as inflation has been at target and the labor market is not as hot. However, inflation expectations will need to be closely monitored given the memory of the latest surge of inflation remains relatively fresh to many consumers and firms. 

Private Credit: Despite a rise in investor concerns about private markets, the ECB downplayed its risk to broader financial stability. Indeed, they noted that its interconnectedness with the traditional banking system is much more limited in the euro area compared to the U.S. Nevertheless, the ECB is paying close attention to recent developments, especially given the opacity and lack of pricing transparency that is typical in this market.

The war in Iran has led the outlook to shift notably since the last ECB staff projections in December. GDP growth in 2026 and 2027 was revised lower while inflation was revised higher, especially for 2026. The ECB now expects inflation to trend above its 2% target through 2028. These baseline projections included information up to March 11, an exceptionally later cut-off date than usual. 

In light of the uncertain outlook, two alternate scenarios were also produced by the ECB staff, which incorporated energy prices staying elevated for some time. The worst of these scenarios points to a surge in inflation together with a euro area recession by the second and third quarter of 2026. 

The ongoing conflict in Iran is a yet another macro shock that is dealing a blow to the global economic environment. The outlook is highly uncertain, with the impact of this shock hinging on the duration, intensity, and propagation of any direct and second-round effects of higher energy prices. As a result, the ECB will be particularly attentive to any supply-chain bottlenecks, the evolution of demand, and any signs of inflation expectations becoming de-anchored. 

President Lagarde noted that the ECB is not only much better positioned compared to the 2022 energy shock, but also better equipped, and they stand ready to ensure inflation normalizes back to its 2% target. Their data-dependent approach implies that policy decisions will remain highly agile. For now, we continue to expect policy rates to remain steady this year, but the recent rise in intensity of the conflict sees us increasing the odds of tightening this year.