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Fuel shock could extend interest rate tightening beyond 2025

Energy prices and, in particular, oil-derived fuels have been boosted in recent months by measures (reductions in supply) enacted by the largest crude oil producers, such as Saudi Arabia, which leads the Organization of the Petroleum Exporting Countries (OPEC), and this is a serious risk that could push inflation much higher again, thus prolonging the framework of very high interest rates for longer.

According to the Organization for Economic Cooperation and Development (OECD), which yesterday released its new interim economic outlook for September, the current scenario (without further shocks to energy and food prices) already virtually guarantees that the European Central Bank (ECB) will keep key interest rates at the current 4.5% (the second highest since the euro came into existence) until the beginning of 2025 at the earliest.

Also according to the OECD, in the current scenario in which inflation remains high but is gradually easing, the economy is beginning to falter (as is already the case in Germany and Portugal).

Against this backdrop, the ECB must stop tightening, the OECD believes: it will not raise its reference rates again, the same rates that directly dictate the level of Euribor interest rates and the cost of bank loans. There is a risk of causing more damage and worsening the recessions that are already on the horizon.

However, in the outlook, the Paris-based organization warns: at this stage, nothing should be taken for granted as the overall balance of risks is “negative”.

One of these risks, perhaps the most prominent and threatening, is that the new wave of inflation in energy and oil will be worse than we think.

Yesterday, the price of a barrel of Brent crude oil, the main benchmark for Europe, approached 100 dollars, surpassing 95 dollars, the highest value in the last ten months, according to AFP.

One thing is certain: the pressure coming from energy prices could provoke an even more violent reaction from the central banks, leading them to insist on further interest rate hikes (when the plan was to end the tightening) or to extend the fixation of interest rates at the current highs, but for longer.

In the case of the ECB, it could be to extend the 4.5% beyond 2025 compared to the scenario assumed in this outlook, for example.

“Energy prices continue to be important for both growth and inflation in the G20 economies” and “the sharp declines in oil, gas and coal prices since their 2022 peaks have contributed to the resumption of growth and lower inflation in the first half of 2023.”

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