ECB’s next move on rates most likely a cut, Villeroy says

PARIS (Reuters) -If the European Central Bank decides to move on interest rates in the next six months, it would most likely be a cut, ECB policymaker Francois Villeroy de Galhau said on Thursday.

The ECB signalled a pause in policy easing this month despite projections showing price growth dipping below its 2% target temporarily due to the strong euro and low oil prices, reviving worries that the ultra-low inflation environment of the pre-pandemic decade could return.

"Barring a major exogenous shock, including possible new military developments in the Middle East, if monetary policy were to move in the next six months, it could be more in the direction of accommodation," Villeroy said in a speech at the European University Institute in Italy.

Crude oil prices jumped 7% on Friday after Israel launched an unprecedented wave of airstrikes on Iran, prompting Tehran to fire hundreds of ballistic missiles at Israel.

Villeroy, who is also governor of the Bank of France, said that the ECB would monitor the situation for signs of a spillover from energy prices into underlying inflation and broader price expectations, which could prompt it to adapt monetary policy accordingly.

While oil prices have risen off recent lows before Israel’s move against Iran, the strength of the euro helps to offset the impact in Europe.

A 10% appreciation in the euro’s exchange rate broadly compensates for the inflationary effect of a 10 euro increase in oil prices, Villeroy said.

Meanwhile, financial market pricing suggests that there is a bigger risk that euro zone inflation undershoots the ECB’s 2% inflation target rather than overshooting it.

The ECB’s own projections this month see inflation falling below 2% in the second quarter of this year and returning to the target in 2027 partly due to the introduction of a new emissions trading system.

"In such a context, we need to remain alert and agile, in all our next meetings," Villeroy said.