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The European Central Bank can further lower interest rates at a time of huge volatility in energy markets, according to one of its most influential rate-setters.
François Villeroy de Galhau, governor of the Banque de France, told the Financial Times that the bombing of Iranian nuclear facilities and the country’s response had not altered the underlying inflation outlook for now.
“If we look at the present assessment of markets so far, inflation expectations remain moderate,” he said, adding that the “significant appreciation of the euro” this year was partly offsetting the recent rise in oil prices. The governor was speaking before the oil price fell sharply late on Monday as US President Donald Trump said Israel and Iran had agreed to a ceasefire.
“If that was confirmed, it could possibly lead in the next six months to a further accommodation [of ECB monetary policy],” he said, referring to central bank jargon for lowering interest rates.
The ECB has halved rates in eight steps to 2 per cent since June 2024, with financial markets pricing in one additional quarter-point cut in the second half of the year. Inflation in May fell slightly below the ECB’s medium-term 2 per cent target, which the central bank expects to meet in 2025.
“Now we are back to normal,” said Villeroy de Galhau, suggesting rates are back at a neutral level, where they neither constrain nor boost growth.
This does not necessarily mean the ECB would keep rates at this level, he said. “A neutral rate and a terminal rate are by nature different animals. They can be the same but they are not identical.”
The former government adviser and banker represents the second-largest member of the currency bloc and holds one of the 26 votes on the ECB’s governing council. He described the conflict in the Middle East as a “new major source of uncertainty” that “can go in both directions”.
While Frankfurt rate-setters “will closely monitor the oil price moves in the near future”, the “oil price per se” was “not a sufficient guide for our reaction function”, he said.
The ECB would have to assess how the exchange rate evolved, if any rises in energy prices were temporary, if they had “spillovers” to other areas of the economy and if they could result in “lasting effects” on inflation, he argued.
“If we were to see spillovers to underlying inflation and de-anchoring of inflation expectations, then we could possibly adapt monetary policy,” he said.
The ECB needed to stick to “data driven” decisions that are taken “meeting by meeting” but also needed to be nimble and willing to react fast, Villeroy de Galhau said. “Thinking a bit more about agility is the new name of the game,” he added. “We will see how things evolve”.
France’s top central banker argued that a potential escalation of trade tensions with the US was unlikely to turn into a meaningful inflation risk for the Eurozone.
“It will have a negative effect on our growth but it should not have an inflationary effect,” he said.
Even if the EU retaliated against US tariffs, the effect on consumer prices in the Euro area would be small because “they will be implemented only on US imports, while in the US they are implemented on all imports”. Moreover, the stronger euro was likely to offset some of the negative price effects.
Asked about the current clash between Trump and Federal Reserve chair Jerome Powell, Villeroy de Galhau said Powell and the FOMC showed “what an independent central banker should do: to tell the truth and to ensure price and financial stability”.
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