ECB's Vujcic Cautions Against Energy-Led Rate Hike Bets

European Central Bank Vice President Boris Vujcic has pushed back against market expectations for further interest rate increases, arguing that investors are placing too much weight on energy prices when anticipating the bank's next moves.

In an interview, Vujcic said the pricing of the interest rate path is being driven mainly by rising energy costs, which have climbed as a widening conflict in the Middle East pushes up fuel prices for the euro zone. He stressed, however, that the ECB does not rely solely on energy prices and instead examines a much broader set of data and criteria. Focusing exclusively on energy, however important, would not be advisable, he said.

The ECB raised its policy rate from 2.0% to 2.50% in two steps in June and September, alongside updated quarterly projections. Vujcic described that pace as worth maintaining for the time being, adding that the bank will watch developments in the coming months and adjust policy accordingly.

Money markets currently price another three or four hikes by the end of next year, with the next increase possibly arriving as soon as October, which would lift the deposit rate to 3.25% or 3.50%. The ECB has described a rate above 2.50% as restrictive, meaning it curbs economic growth. Vujcic said the bank should not fixate on such labels but instead assess what level of interest rates is appropriate at a given point.

He warned that persistently high energy prices would not only fuel inflation but could also weaken growth by squeezing household incomes and spending. If inflation remains elevated through the autumn and affects consumer behaviour, that would have a dampening impact on GDP, he said, adding that a cold winter would compound the hit through higher heating bills.

At the same time, Vujcic noted that the euro zone has reduced its reliance on natural gas over the past four years, making low storage levels less of a threat than when Russia invaded Ukraine in 2022. The economy has also proven more resilient than expected, supported by exports, where buyers likely brought forward some purchases, and by private consumption, which is expected to remain reasonably solid.

On liquidity, Vujcic opened the door to raising bank reserve requirements as a way to drain some of the excess liquidity left over from years of stimulus, which costs euro-area central banks billions of euros in interest payments annually. He said reserve requirements allow part of that liquidity to be sterilised simply and inexpensively, and that he prefers this approach to alternatives such as charging fees or reviving a complicated tiered rate.

Turning to bond markets, where yields have climbed to levels not seen since before the financial crisis on higher inflation and rate expectations and large government and corporate borrowing needs, Vujcic said the moves do not threaten financial stability because euro zone banks are well capitalised and liquid. He nonetheless urged governments to keep public finances under control, saying responsible fiscal policy remains an essential part of the puzzle in the long run.