The vice-president of the ECB, Luis de Guindos, stated today that the prospects for the European economy are now “clearly defined” by the conflict in the Middle East, which has “increased the level of uncertainty”, mainly regarding the evolution of inflation.
Faced with this situation, Guindos warned that the ECB (European Central Bank) has to work on different scenarios for the European economy, depending on the duration of the conflict triggered by the attacks by the United States and Israel on Iran last Saturday and if it becomes “more global”.
“The basic scenario is that it will be a short conflict and the other is that it will be longer, more prolonged than we expected,” explained Guindos at an event organized by the International Finance Forum in Brussels.
In this sense, Guindos specified that the ECB will pay attention when defining its monetary policy to price developments and the possible change in inflation expectations, which he associated in particular with the duration of the conflict.
“If it is longer lasting, then there is a risk that inflation expectations will change,” he warned.
However, the vice-president of the ECB highlighted that, “so far”, the markets’ reaction to the conflict has been “orderly”, with an appreciation of the dollar and a slight increase in the interest rate on sovereign bonds.
He recalled that, before the conflict, the European economy had shown itself to be “more resilient than expected”, with historic lows in unemployment, a positive evolution of inflation and a “balanced” balance of risks, which is why he argued that, in this context, the level of interest rates adopted by the ECB “is the correct one”.
Regarding financial stability on the continent, Guindos indicated that the main vulnerabilities come from the “very high” asset valuations and the “very optimistic” view on the part of the markets of the global economy, which “may not be real”.
“Perhaps what happened over the weekend was a kind of alarm signal about the potential risk that we are analyzing,” he said, referring to the attacks against Iran.
Other vulnerabilities come from non-bank financial entities and their links with the traditional banking system and the budgetary situation of European countries in a context in which they must increase their spending, particularly in defense, and at the same time ensure budgetary sustainability.
“It’s going to be squaring the circle”, he estimated.
In this sense, Guindos defended, in a personal capacity, the issuance of joint debt by the European Union to finance defense spending, in a similar way to what was done with the post-pandemic recovery fund.
“Given the priority we attribute to defense spending and budget limitations, I think this should be a real alternative,” he proposed.
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