Jacob Kirkegaard is an economist at two major international think tanks: Bruegl based in Brussels, and the Peterston Intitute of Internatioanl Economics in Washington D.C. Like other economists he did not expect the European Central Bank to hike its key rate this week after raising it in June for the first time since 2023; and he too sees the ECB’s door wide open to an interest hike at its next meeting in September.
Jacob brings a special background and knowledge to the table as he vets the odds of a rate increase next month, and looks at the key forces driving the ECB and other central banks around the world now. He started his career years ago Denmark’s Ministry of Defense where he graduated from Danish Army Special School of Intelligence and Linguistics as a first Lieutenant, and also worked with the United Nations in Iraq, before going to work in financial markets.
So he offers special perspective on ECB policy amid the ongoing Middle East conflict and its impact on global oil prices and inflation. Drawing on his background in military intelligence and economics, Jacob’s views are shaped by the intersection of geopolitics and central banking, emphasizing the challenges faced by policymakers in an unpredictable environment.
With the Middle East conflct back in high gear, and the easing in EU inflation seen in June likely to be erased and replaced by rising oil prices in the July numbers, are these the main forces that will determine what the ECB does next?
“The euro area had, you know, close to or at a record low unemployment. It had, you know, inflation back at 2%. And therefore the central bank could basically declare victory. Well, then the war happened, and it now is in a situation where it has to essentially decide, is this geopolitical shock of a magnitude similar to the one that it faced... after the Russian invasion of Ukraine?”
Jacob argues that while the current shock is not as severe as the Ukraine crisis, the ECB cannot ignore it. He expects another rate hike in September, even if oil prices temporarily fall.
“I actually believe that a majority in the council is likely to vote to hike again in September, even if oil prices come back again before that.”
”I think, fundamentally, this is about what happens in global energy markets, and therefore, to a large extent, about the wars.”
“The reality is that this is a war that Donald Trump started, and therefore he is the person, in my opinion, to also end it... he has had a much higher political pain threshold for the blowback from this war on obviously, US gasoline prices, politics.”
When the war started in February Jacob thought the war would end sooner that it has, even as was adamant that this war would not force regime change in Iran now.
“There is no military solution to this war. There may be escalation again in the near term, but the question is, will that bring a solution closer? Will that bring the reopening of the Strait of Hormuz closer? I don’t believe it will.”
Jacob explains that Iran’s resilience is due to both economic and tactical factors:
“Iran is a very brutal regime... only susceptible to economic pressures in, at best, the medium term... And the other reason is more military tactical, which is that Iran is able to close the Strait of Hormuz... using long range drones... and therefore the threat to the strait continues to exist.”
So dive in and hear why Jacob sees a necessary shift in central banking, away from forward guidance and toward data dependence.
Spoiler alert: he says the ECB and all central banks must “change their modus oprandi” now that it’s all about geopolitical shocks. And markets must realize this too.
“I think everybody has to recognize that when you are in a more geopolitical world where these types of risks play a bigger role for what central banks have to do, and these are totally outside anything the central banks can do anything about, then we just simply have to accept that the most prudent thing central banks can do is to be, yes, data dependent, and work on a meeting by meeting basis.”
Jacob Kirkigaard on ECB and war disruption final transcript to post
The war, the war, the war…and energy prices 00:01:49:06
The unfortunate reality that the ECB is facing. I mean, to some extent, if we take a step back and look at the situation that the ECB confronted earlier in this year before the war broke out, they basically declared victory as, as you know, pristine. Lagarde used to say we’re in a good place.
In a good place but with a high inflation rate 00:02:15:10
The euro area had, you know, close to or at a record low unemployment. It had, you know, inflation back at 2%. And therefore the central bank could basically declare victory. Well, then the war happened, and it now is in a situation where it has to essentially decide, is this geopolitical shock of a magnitude similar to the one that it faced, or the eurozone face the Europe faced after the Russian invasion of Ukraine?
Central bank that did a good job-but is back in the soup 00:02:53:07
I think it’s pretty clear that it’s not. But on the other hand, can be ECB. Clearly they’ve decided not to just look through this. They’ve already hiked once and as you alluded to, and I fully agree to that, I think it is the strong base case that they will hike again come September. But maybe that’s it. But it doesn’t change the fact that here is a central bank that essentially did its job, kept inflation expectations well anchored in the eurozone back at 2%. And then another geopolitical shock happened. And it now has to adjust to that fact in its monetary policy. And even though, of course, geopolitics is something that is completely outside the realm of central banking, they are just active.
ECB pattern: change rates around the time of their forecasts 00:04:24:04
Yeah. I mean, I think if you look at it we have a pretty clear pattern developed over the last couple of years of ECB, you know, monetary policy changes, namely that they prefer to do them around the time when they’re also updating their macroeconomic forecasts. That happened in June. It obviously didn’t happen this week, but it will happen again in September.
Oil now back above previous forecast levels 00:04:47:20
And I think if you look at if you go back to the June forecast, they had an assumption of Brant, all for this year on average at 96 point something dollars. We are now above that level. We were way below that level in June, as you highlighted, and the June report came in euros. The numbers came in very benign, very much back to exactly the range that the ECB would like to see.
Here forward we will see deal skepticism 00:05:20:03
I think we’d have to assume that because all prices are back up, but the July numbers are correspondingly worse. And I would even go as far as to say that even if you have, which actually, by the way, I think is the base case before the September meeting, some sort of renewed initiation of diplomacy between the US and Iran likely to drive all prices back down again.
ECB probably has a rate hike pending for September 00:05:47:10
But we’ve seen now prices go back up above the level that the ECB assumed. So I would I actually believe that a majority in the council is likely to vote to hike again in September, even if our prices come back again before that.
Oops…it has not turned out to be short 00:06:44:04
I absolutely thought it was going to be a shorter war. The reality is that this is a war that Donald Trump started, and therefore he is the person, in my opinion, to also end it. And he has somewhat in contrast to my initial belief, have had a much higher political pain threshold for the blowback from this war on obviously, US gasoline prices, politics.
The bomb ‘em strategy was a bomb 00:07:22:07
It’s well known that it’s a controversial issue in Washington how expensive this war has become, but he’s been willing to basically absorb, you know, quite punishing polls, even though it’s a midterm election year. So I that has surprised me. And I think fundamentally, that’s why we do not have an end to this war yet, because unfortunately, it was always my belief, and I think the belief of most military analysts, that the idea that the US and Israel could sort of bomb Iran into submission, you know, the regime change argument, that was always a fantasy.
…and escalation has not worked 00:08:10:07
It was never, frankly, credible. And that is exactly what we have seen. So what has happened, in my opinion, is that Donald Trump was pushed, not least by, you know, all prices approaching, you know, well over $100 to sign the MOU, the ceasefire, if you like, with Iran. Oil prices then came down very dramatically. You know, almost as far back as before the war started. Trump then used that, if you like, policy space to not finalize the deal with Iran, but rather partly because the Iranians were very belligerent. They kept firing at ships in the Gulf. Trump, you know, fired back. And now we’ve had 13 days of uninterrupted you as bombing of Iran. So he basically chose to militarily escalate. But it’s also clear that that military escalation so far has had no effect.
Will further escalation work? 00:09:18:02
Right? Iran is still shooting at ships in the Gulf. The Houthis have now joined in. That’s not necessarily that’s for their own reasons. But the point is that there is no military solution to this war. There may be escalation again in the near term, but the question is, will that bring a solution closer? Will that bring the reopening of the Strait of Hormuz closer? I don’t believe it will. Only at least if escalation is kind of the last. Hooray! You know, Trump does one more bombing run on Pickax Mountain, the Iranian nuclear facilities, and then says, okay, you know, we’ve annihilated the program, we’re ready to go home. So it’s kind of an off ramp. Otherwise, I fear we could be in another escalatory cycle and all prices would have to go much higher, at least as much higher.
Resilient Iran partly because of US choices 00:10:38:11
Oh, there’s no doubt that the Iranian economy has been very severely affected, and especially in the last couple of weeks, where Trump has given away, he’s taken away the goodies that he gave Iran during the war because you had this, you know, very surprising outcome that the US started bombing you on. But then because the administration was very afraid of the effect of the war on oil prices, it issued a sanctions waiver on it basically did away with the existing sanctions on Iranian oil sales. So basically giving in Iran. Iran, a financial windfall during the war, which is, you know, kind of if not absurd, then at least, you know, surprising, I would say that is now gone. So Iran is back to having it’s all subject to US financial sanctions. There is a naval blockade in place of Iran. They are hurting, there’s no doubt about that.
Too brutal to be pressured 00:11:41:02
But Iran is a very brutal regime. They gunned down probably tens of thousands of Iranian civilians back in January that were protesting economic hardship. That type of regime is only, you know, susceptible to economic pressures in, at best, the medium term, certainly well past the US midterms. And that is why military pressure isn’t going to change Iran’s short term calculation.
Iran has a firm low tech hard-to-stop grip on the strait 00:12:14:20
And the other reason is more military tactical, which is that Iran is able to close the Strait of Hormuz not using mines or using the Iranian navy, which has essentially been destroyed, but using long range drones, drones that can be fired from the back of a truck. And that military threat, the US and Israel have no immediate response to all the bombing they’ve done, haven’t destroyed all the Iranian drones, and therefore the threat to the strait continues to exist. And that is what is given giving in the near term, Iran a strong, stronger hand. I don’t think there’s any doubt about that.
A step too far- boots on the ground 00:13:17:24
Yes. I mean, if you want to militarily address the Iranian threat to the Strait of Hormuz, yes, you would need to invade and conquer a large chunk of Iranian territory, maybe even overthrow the entire government. But you would, at a minimum, need to take several hundred miles of territory inland around the strait, because you want you need to physically remove the threat of drones.
Not easy to occupy… no means to end the war 00:13:49:10
This is mountainous territory. It would require hundreds of thousands of troops. It would undoubtedly be very, very bloody. And, you know, quite understandably so. The president has no. And the American people, I believe, has no desire for such a war. What that unfortunately means is that Donald Trump has no military means with which to end the conflict that he has started.
Putin’s oil facilities are being struck 00:14:44:22
Well, there’s no doubt that Ukraine’s effective strikes on the Russian refining sector is driving a very severe fuel shortage throughout the Russian economy, including in the Russian military. What you have seen is, I mean, that probably has, I would say at least two major effects on global oil and energy markets. One is that for us, well, if you can’t refine it domestically because your refineries have been blown up, you need to export more crude oil instead.
Russia is importing gas and diesel 00:15:22:12
So that’s what Russia, you know, of course, have done. And they have benefited to some extent from higher all prices. Now Ukrainians have understood that very well. So they’ve also been bombing Russia’s crude oil export facilities around in the Baltic Sea and the Black Sea, etc.. And then you have more recently this quite extraordinary development that Russia, a very large scale producer, is now forced to import gasoline and diesel from India. And that is quite a remarkable reversal for what, at least until recently, was a major oil and refined products exporter. And of course, if Russia suddenly has to import refined products, well, that’s extra demand globally. So that is good for refining margins and good for prices of these refined products. So there is no doubt that the war in Ukraine continues to exert influence.
Knock-on effects in the Black Sea 00:16:30:14
Also global oil markets. There are also another recent development which is that the Ukrainians bombed the or have been bombing tankers in the Black Sea that has also affected Kazakh. All exports that go through the Black Sea. So that’s another if you like, supply disruption for the global oil markets related to the Russia Ukraine war. So it’s not only about US Iran, even if that is the obviously principally driving force.
ECB has only a price mandate 00:18:02:06
No, I mean it is a it is the principal driving factor of EU euro area headline inflation, which is of course the EU’s mandate. They don’t you know, they don’t have they don’t have an employment mandate. They don’t have a dual mandate. They have a headline inflation mandate. And all prices where they are have driven it up. Right.
00:18:20:12 - 00:18:47:13
Jacob Kirkegaard
It used to be about two. Now it’s you know, it was briefly around three. Now it’s come down a little probably go back up. I would say there are basically there are two main channels. All prices is the obvious first one, but the other one that until now have been largely forgotten or not forgotten, but not less relevant, which is natural gas, because LNG.
LNG matters for Europe 00:18:47:15
Now that Europe has ended imports of pipeline gas from Russia, LNG supplies to Europe are very important for gas prices here on natural gas prices here, natural gas prices, when the memorandum was signed came back down dramatically in Europe, well below, in fact, the ECB assumptions for gas prices. But they’re not back up because the fear is that Qatari supplies are not going to be available until maybe even the end of the year.
…and needs to refill storage 00:19:26:13
And Europe faces, you know, it needs to refill its low storage of natural gas for the winter season. So European natural gas prices have come up quite significantly in recent weeks, to the point where no doubt that the ECB may even be looking at that more than all the prices. And the reason for that is that natural gas prices, potentially under the right unfortunate circumstances, vary directly affect European electricity prices.
Gas is the ‘swing fuel’ for electricity generation 00:20:06:17
And that’s really where the average European can be negatively affected. And the reason for that is, of course, that, you know, gas, gas fired power plants are the swing producer of power in many European countries. So even though we’ve had a dramatic expansion of renewables, solar, wind, batteries, natural gas prices still matter a lot. So this is certainly one market that I think the ECB will pay, as I said, possibly even more focus on than all prices in the coming months.
No Euro-political shocks 00:21:24:22
I mean, macroeconomics, I think the answer is no, because again, you know, before this war started, macroeconomics in the eurozone was kind of boring, actually. Right. And government budgets for next year are already in the pipeline. There’s not very much new there. We’re not going to have dramatic new government changes, elections. And these times there’ll be a lot of elections in the eurozone, but only in 2027, in France and elsewhere.
Trade war dodged 00:21:59:24
So what you’re left with are other types of policy shocks, I would say. And actually, just in the last couple of days, I would say we have probably averted a very big one there, namely a resumption of the US EU trade war, because when the Trump administration yesterday announced its, you know, shift from 122 to 301 type tariffs, the ECB sorry, the EU only got 10%, which is basically the same as saying that the last year’s trade agreement or trade cease fire or whatever we choose to call it still stands. So we’re not going to have a resumption of EU, US tariff wars. Looks like that. And that probably removes the the single biggest risk from the ECB point of view. There is one more trade you know torpedo out there which is EU China where the deadline for some sort of arrangement is October. So again it’s something that the ECB will be looking at but not necessarily play a big role in the September discussion.
War is THE FOCUS 00:23:25:18
So as you look at this, no, I think fundamentally this is about what happens in global energy markets and therefore to a large extent about the wars.
Germany faces headwinds- loss of energy supply 00:23:44:15 -
Yeah, I think the German economy is facing a confluence of structural headwinds. Some of them are entirely Germany’s own fault. A large one of their is chronically high energy prices. And the principal driver of that, of course, is the disastrous policies of Angela Merkel and others for relying on Russian gas that was very expensive to get out of shift very rapidly in, in implemented but very expensive shift to global LNG instead.
…and Germany dumped nuclear, China challeneges 00:24:23:21
And then of course, the phase out of nuclear power, which was again, in today’s day and age and ideological insanity pushed by by the German Green Party. But then Germany faces very significant and accelerating population aging. And then Germany also has a structural direct challenge from China in many of its traditional manufacturing machine tool to export dependent industries.
Enormous fiscal stimulus to combat weakness 00:25:02:03
So Germany faces a lot of headwinds. Germany has a potential growth rate probably today, about only about half a percentage point per year. So what they have done is they’ve obviously launched largely for geopolitical reasons. This enormous fiscal stimulus focused on rearmament and public infrastructure investments. These are all necessary and good things, in my opinion, and I think they will, if you like, animate some of the animal spirits in the German private sector as well, that they they’re going to be starting investing again because they know growth is coming from this big stimulus.
...and more deregulatory moves 00:25:51:06
And then and this is maybe even more or equally important, you know, the German government has begun some more important long term structural reforms. They launched and will approve a significant pension reform later this year that will raise the retirement age and begin pre-funding German pensions, etc. they have also proposed not enough, but some easing of German labor market regulation. They have done a lot about permitting. It’s much easier to get a permit today to actually build new plants, etc. in Germany. So they’re pushing in the right direction. This will also help private business sentiment. But you know they still have a long way to go.
Central banks abandon their ‘new tools’ 00:27:48:24
…Ten years ago in the eurozone…. You were at the zero lower bound. I mean, you were looking at a very explicit deflationary threat. Then you developed new policy tools, you know, quantitative easing or the ECB version of that. Obviously, that meaning, you know, negative nominal rates in the ECB, case and yes, for guidance, but none of that applies anymore.
Quite simply- no longer needed 00:28:26:18
So I think it’s good that the ECB and other central banks change their, you know, modus operandi when it comes to formulating and not least communicating monetary policy. I don’t see really the use of forward guidance when you are subject to when the biggest concern or uncertainty out there is not how to avoid structural deflation, because that’s where it was useful.
If ‘shocks’ proliferate forward guidance is a particularly bad idea 00:29:02:02
That was when it was, I think, you know, sort of widely adopted. Today. It’s about geopolitical shocks. And if you overcommit or, you know, put yourself out there with forward guidance and then all of a sudden Donald Trump or, you know, Vladimir Putin or Iran does something else, you have to reverse yourself. But it’s very bad for your credibility.
A hand-to-mouth existence 00:29:27:09
And I think there for that markets everybody has to recognize that when you are in a more geopolitical world where these types of risks play a bigger role for what central banks have to do, and these are totally outside anything the central banks can do anything about, then we just simply have to accept that the most prudent thing central banks can do is to be, yes, data dependent, and work on a meeting by meeting basis.
Different times; different tactics 00:30:03:01
And I think that is at least some of the ‘reforms ‘or changes in the air… Some of the adjustments that central banks are making, are simply because, yes, we are living in an era where different type of shocks are what dictates the economy, the economic outlook, and therefore of course, also should dictate monetary policy.
JACOB FUNK KIRKEGAARD
Jacob Funk Kirkegaard has been nonresident senior fellow with the Peterson Institute for International Economics (PIIE) since September 2020 and resident senior fellow with Bruegel since September 2024. He was a resident senior fellow with the German Marshall Fund of the United States (GMF) in the GMF’s Brussels office from September 2020 to August 2024. He has been associated with the Institute since 2002 and had been resident senior fellow from 2013 to 2020.
Before joining the Institute, he worked with the Danish Ministry of Defense, the United Nations in Iraq, and in the private financial sector. He is a graduate of the Danish Army’s Special School of Intelligence and Linguistics with the rank of first lieutenant; the University of Aarhus in Aarhus, Denmark; the Columbia University in New York; and received his PhD from Johns Hopkins University, School of Advanced International Studies.
He is coeditor of Transatlantic Economic Challenges in an Era of Growing Multipolarity (2012), author of The Accelerating Decline in America’s High-Skilled Workforce: Implications for Immigration Policy (2007), coauthor of US Pension Reform: Lessons from Other Countries (2009) and Transforming the European Economy (2004), and assisted with Accelerating the Globalization of America: The Role for Information Technology (2006).
His current research focuses on European economies and reform, immigration, foreign direct investment trends and estimations, pension systems, demographics, offshoring, and the impact of information technology.
