Geopolitical détente reshapes the narrative around energy shocks. French central bank governor Mùlèn: the ECB is in a “good position.”

As geopolitical tensions ease and push oil prices lower, the energy import-driven inflation pressure on the eurozone continues to ease, and market expectations for further rate hikes by the European Central Bank have significantly cooled.

On July 3, François Villeroy de Galhau, Governor of the Bank of France and ECB Governing Council member, said at the Aix-en-Provence Economic Forum that after completing the rate hike in June, the ECB is in a "good position." He said, "It is still too early to judge the policy direction for the July and September meetings. Future policy will adhere to data dependence, will not provide forward guidance, and does not imply the start of a new cycle of sustained rate hikes."

As the impact of the energy shock diminishes, divisions within the ECB on subsequent policy are also gradually emerging. On one hand, some officials believe that falling oil prices and cooling inflation provide room for a pause in rate hikes; on the other hand, some are concerned that previous energy costs may still be transmitted with a lag through wages and service prices, and policy still needs to remain cautious.

Falling oil prices ease inflation pressure, ECB emphasizes data dependence

Villeroy de Galhau said that the recent fall in oil prices is easing price pressures in the eurozone, especially helping to curb services inflation. At present, the ECB has not seen a "second-round effect" of energy price increases being transmitted to broader areas such as wages and services, meaning that the inflation spiral risk previously feared by the market has not yet materialized.

At its June meeting, the ECB unanimously supported a 25-basis-point rate hike, with officials generally worried at the time that rising oil prices could push up broader inflation pressures. But since then, as geopolitical improvements have driven oil prices lower and eurozone inflation has cooled more than expected, views within the bank on whether to continue tightening have begun to diverge.

The market has also adjusted its policy expectations accordingly, with investors significantly reducing their bets on further rate hikes by the ECB this year. As the impact of energy prices on inflation weakens, the future interest rate path in the eurozone will depend more on data such as core inflation and wage growth, and the ECB will continue to adhere to a meeting-by-meeting, data-dependent decision-making framework.

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