Uncertainty remains high. In contrast to earlier expectations, the conflict in Middle East still continues, supply routes remain constrained. Oil prices remain elevated and may remain high for longer. Inflation pressures have broadened with euro area headline inflation in May climbing to 3.2% (from 3.0% in April) and core to 2.5% (2.2%). Goods inflation has inched up to 0.9% (0.8%) and services inflation stood at 3.5% (3.0%). Significant second round effects so far are not present and medium-to-long term inflation expectations remain anchored. Short term inflation expectations have increased considerably since the outbreak of the conflict and corporates are signalling of increasing price pressures likely leading to further short-term price increase.
To contain further broadening of inflation pressures and limit second order effects, last Thursday the ECB Governing Council decided unanimously to raise its policy rates by 25 basis points. Such a measured pace is appropriate and robust across a range of scenarios (both on the upside and downside from the baseline). The oil price developments have recently been slow evolving and monetary policy transmission remains good, which allows to adjust policy rates in a measured way. With this rate decision ECB Governing Council remains well-positioned to act against further developments to contain inflationary pressures and push it back to the 2% target over medium term.
In the current forecast update, headline inflation forecast has been raised to 3.0% in 2026 (2.6% in March forecast), 2.3% (2.0%) in 2027 and 2.0% (2.1%) in 2028. Core is now forecast at 2.5% (2.3%) in 2026, 2.5% (2.2%) in 2027 and 2.2% (2.1%) in 2028. Growth has been revised to 0.8% (0.9%) for 2026, 1.2% (1.3%) in 2027 and 1.5% (1.4%) in 2028. Compared to inflation, revisions to growth are small, since most of the adjustment was done in March forecast. The current forecast does not include the revised 1Q 2026 GDP data to -0.2% mom as it came after the forecast cut-off date. Though, it would not have affected the policy decision as the growth revision is largely due to Ireland (excluding Ireland, the euro area economy grew by 0.3%) which is of an accounting nature rather than underlying economic strength.
Drawn out Middle East conflict and longer lasting supply interruptions mean a larger drawdown of oil reserves, hence restocking of reserves is likely to take longer. This means that high oil prices may linger on for longer. With albeit somewhat cooling but still quite tight labour market, this may raise inflation persistence, the risk of later second round effects and nonlinearities. Furthermore, this energy shock is global and thus may have a broader impact via import prices. Hence risks to inflation remain on the upside. With uncertainty high, inflation still to climb, risks to growth are on the downside.
In view of high uncertainty, it is appropriate to retain our reaction function and modus operandi of data dependent, meeting-by-meeting decisions without a preset rate path. Every meeting is a live meeting with full optionality to ensure a timely return of inflation to the 2% target.