UPDATE 2-Inflation surge and eroding growth raise policy dilemma for ECB

Still, financial investors are betting on a rate hike ⁠by ​the summer, followed by another move or two later in the year, modest increases that may not slow growth too much but clearly signal that the ECB will not let high inflation get entrenched. "This morning’s data provides more evidence that the war in the Middle East and the rise in energy prices ⁠are not only posing an inflationary shock but rather a stagflationary shock for the euro zone economy," ING economist Carsten Brzeski said.

Euro zone inflation expectations are surging on ‌the ​fallout from the Iran war but economic growth is faltering, separate European Central Bank surveys showed, raising a policy dilemma as opposing forces tug the bloc in different directions. The ECB is expected to keep interest rates on hold ‌at a meeting on Thursday but hikes are likely to be on the table at the next meeting in June as policymakers worry that an initial energy-induced price shock could linger and push up inflation over the longer term.

The dilemma is that rate hikes help ease price pressure but also hit economic growth, which is already suffering ‌from high energy, tariffs and uncertainty, raising the risk that the ECB's inflation fight aggravates an already precarious situation. The ECB's Consumer Expectations Survey showed inflation expectations for ‌one year ahead jumped to 4.0% in March from 2.5% a month earlier while bets for three years out rose to 3.0% from 2.5%, both well above the ECB's 2% target.

But the central bank's quarterly Bank Lending Survey indicated lenders had tightened their criteria to approve loans by more than expected in the three months to March and expected to continue doing so this quarter. LONGER ⁠TERM INFLATION EXPECTATIONS ​BARELY MOVED

The surveys come just a ⁠day after the ECB's own poll of businesses showed moderating profit and wage expectations as energy prices push up costs and weaken margins. "Taken together, the three surveys paint a gloomy picture," Alexander Valentin ⁠at Oxford Economics said. "We read these data as further evidence for ECB rate hikes ahead, despite the growth-inflation dilemma the Governing Council now finds itself in."

Policymakers may take some comfort in ​longer term inflation expectations, which barely moved in either the consumer or business survey. And banks were already doing some of the ECB's work for ⁠it by making credit harder to get, particularly for firms which saw the sharpest tightening since the third quarter of 2023.

MODEST RATE RISES ON THE CARDS? Still, financial investors are betting on a rate hike ⁠by ​the summer, followed by another move or two later in the year, modest increases that may not slow growth too much but clearly signal that the ECB will not let high inflation get entrenched.

"This morning’s data provides more evidence that the war in the Middle East and the rise in energy prices ⁠are not only posing an inflationary shock but rather a stagflationary shock for the euro zone economy," ING economist Carsten Brzeski said. "Growing signs of adverse growth effects ⁠will make aggressive rate hikes less straightforward," ⁠he added.

The war is likely to keep weighing on the outlook. Consumers expect a deep recession while banks see both a fall in loan demand and a rise in lending costs.

"Perceived risks to the economic outlook and a lower ‌risk tolerance of banks were ‌the main contributing factors, with banks indicating ... that geopolitical and energy developments exerted tightening pressure," ​the ECB said. (Editing by Alison Williams)