By Belgian MEP Johan Van Overtveldt (Belgian Finance Minister between 2014 and 2018, Chairman of the European Parliament’s Budget Committee)
Will the ECB avoid repeating its major policy mistake of 2021–22, when it reacted almost a year too late to rising inflation? To keep inflation expectations well anchored, interest rates will need to rise soon.
It did not require exceptional economic foresight to anticipate that the Iran war, and its significant impact on oil and gas prices, would quickly translate into a substantial increase in overall inflation. After stabilizing at 2.4% in the first months of this year, annualized inflation in the United States rose to 3.3% in March, largely driven by higher energy prices. In the euro area, annualized inflation stood at 1.7% in January and subsequently increased—again mainly due to rising energy prices—to 1.9% in February, 2.6% in March, and 3% in April.
In the euro area, the profile of inflation dynamics has recently changed markedly. Inflation peaked at 10.6% (annualized) in October 2022 and then gradually declined, coming close to the European Central Bank’s (ECB) target of 2% in both 2024 and 2025. Falling energy prices played an important role in this downward trend. In January of this year, energy prices declined by 4% (annualized), and by 3.1% in February. However, in March, energy prices increased by 5.1%, and in April by an even sharper 10.9%.
What has remained stubbornly elevated in recent years is inflation in the services sector, which accounts for roughly two-thirds of the euro area economy. Services inflation has broadly fluctuated between 3% and 4% annually. Previously, declining energy prices masked the persistence of inflation in this larger part of the economy. Now that energy prices have reversed course sharply, overall inflation is being pushed upward by two powerful forces.
Unless unexpected positive developments—such as lasting peace in and around Iran—begin to ease inflationary pressures, further increases in overall inflation are likely. At her press conference at the end of April, ECB President Christine Lagarde stated that “for now we’re not seeing second-round effects.” While this is broadly accurate, it is likely to become outdated in the coming months. Food prices are beginning to rise significantly, and substantial price increases are also becoming evident in raw materials. A recent survey by the Financial Times of first-quarter earnings calls among S&P 500 companies showed that mentions of “surcharges” (additional price increases) have reached their highest level since at least 2018.
President Lagarde is clearly aware of what lies ahead on the inflation front; otherwise, she would not have remarked, “I think directionally I know where we’re heading.” In plain terms, this suggests that after keeping the key policy rate (the deposit rate) unchanged at 2% since June 2025—and reaffirming it at the April ECB Governing Council meeting—a rate increase is highly likely at the June meeting. One can only hope that the ECB will not repeat its major mistake of five years ago, when it responded far too late to rising inflation.
History lesson
In the spring and early summer of 2021, annualized inflation in the euro area remained fairly stable around the ECB’s 2% target. By August 2021, inflation had risen to 3%, and it continued climbing to 5% by the end of the year, largely driven by energy prices. At the time, most ECB policymakers considered this increase to be temporary. However, doubts about this assessment were already being raised.
When Vladimir Putin launched the war against Ukraine in February 2022, energy prices surged dramatically. By March, inflation had already reached 7.4%, and by June it had climbed further to 8.6%. Yet it was only in July 2022 that the ECB began to act, raising the deposit rate to 0%. This key policy rate had been in negative territory since early 2014.
Serious and credible action by the ECB only began in September 2022—roughly a year after the first signs of significant inflationary pressures had emerged. Alarmed by its earlier misjudgment, the ECB then moved rapidly, raising the deposit rate to 4% by September 2023—a dramatic tightening of monetary policy within just over a year. Inflation responded quickly to this aggressive stance, falling from its October 2022 peak of 10.6% to 4.3% by September 2023. Subsequently, inflation in the euro area moved back into the 2%–3% range.
Unlike in the 1970s, President Lagarde stated at the end of April that “we will tame inflation.” However, the more relevant comparison may be with the ECB’s missteps in 2021–22. To keep inflation under control, it is crucial that inflation expectations remain well anchored. In simple terms, this means that consumers and producers continue to behave as if the 2% inflation target will be firmly upheld. If that belief fades, prices across the economy are likely to rise further, as expectations of higher inflation become self-fulfilling.
For the credibility of the 2% target to be maintained, the central bank must send a clear and decisive signal that it will act accordingly. That moment has now arrived. Given current inflation developments, reassuring words alone are no longer sufficient. Despite the negative impact that higher interest rates will have on public finances—particularly in highly indebted countries—restrictive monetary policy has become imperative for the ECB.
Originally published on the blog of Johan Van Overtveldt.
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