The European Central Bank is in a dilemma: market expectations are naturally tightening, and the private sector is now acting as a "brake" for the central bank.

Notice that policy makers at the European Central Bank are facing a dilemma: on the one hand, measures to curb inflationary pressures through raising interest rates risk pushing the fragile eurozone economy into recession; but on the other hand, they may not need to intervene personally to achieve policy effects. Goldman Sachs European economist Alexander Stott said that market expectations of future contractionary monetary policy (i.e. interest rate hikes) have already led to stricter financial and lending conditions. In a report released on Wednesday, Stott wrote: "The transmission of contractionary policy has already begun." Stott pointed out: "The tightening of bank credit standards is particularly significant, and may tighten further in the future. This is particularly important in the eurozone, where loans account for over half of all corporate financing." He also added that the current challenge is to assess how much restrictive impact is being transmitted to the real economy. He said: "On the one hand, most of the current restrictive impact is attributed to expectations of higher policy rates. Therefore, if the committee wants to suppress demand and counter inflationary pressures, they must at least partially fulfill the expectations of raising interest rates." "But on the other hand, about a quarter of the resistance the economy is facing seems to be from external factors beyond monetary policy expectations, reducing the necessity of a significant contractionary policy. Under same conditions, this will support a cautious approach to interest rate hikes, which is consistent with our forecast of raising rates by 25 basis points in June and September respectively." Market expectations Currently, the market predicts that the European Central Bank is highly likely to raise interest rates by 25 basis points at its next meeting on June 11 (about 91%) - this would raise its key deposit facility rate to 2.25% - and predicts a 50% chance of another rate hike later this year in September. Due to the surge in consumer prices in the eurozone caused by the Iran conflict, the eurozone inflation rate has jumped to 3% as of April, making an interest rate hike increasingly likely. The next inflation data will be released on June 2. European Central Bank policy makers reiterated the stance of President Lagarde, stating that they will take a data-dependent and step-by-step evaluation approach to monetary policy. European Central Bank Vice President Luis de Guindos told the media on Wednesday that national central banks must balance the necessity of curbing inflation with avoiding excessive pressure on economic output. De Guindos said, "I think there are no established facts regarding the evolution of interest rates. The discussion will be open, and all factors will be balanced and considered." Similarly, Franois Villeroy de Galhau, Governor of the French central bank and a member of the European Central Bank's Governing Council, told the media earlier this week that European policy makers "will take necessary steps" to bring the inflation rate back to the target of 2%. European Central Bank credibility tested Given the weak economic growth in the eurozone, economists are divided on whether the European Central Bank should raise interest rates; the latest data shows that the eurozone economy grew by only 0.1% in the first quarter. Holger Schmieding, Chief Economist at Berenberg Bank, said last week that the "Big Three" economies in Europe - Germany, France, and Italy - have been weakened by recent surges in energy costs, leading to a stagflation environment characterized by rising inflation, unemployment, and slowing growth. Schmieding believes that demand destruction should "automatically resolve" the inflation part of the stagflation dilemma, as consumers will reduce spending on other goods to pay for higher energy costs - eliminating the need for aggressive contractionary measures. "It's important to distinguish between what the central bank might unfortunately do and what it should do," Schmieding told last week, adding, "My impression is that the European Central Bank is about to make a big mistake." Philippe Altai, Head of Financial Credit at Federated Hermes, said in a report on Thursday that the European Central Bank is in a dilemma. He said, "The impact of the disruption to Middle East energy infrastructure on the economy is severe and full of uncertainty. Even if tensions ease, oil prices are likely to remain structurally high," and pointed out that countries like Germany and Italy are especially vulnerable to prolonged energy cost shocks. "At the same time, the European Central Bank is dealing with the legacy issues of past policy mistakes, namely keeping interest rates too low for too long after the pandemic," he added. "Therefore, the central bank is now under increasing pressure to respond decisively to inflation pressures and second-round effects. Anchoring inflation expectations has become crucial, indicating the need to... raise interest rates by 25 basis points as early as June." Altai said, ultimately, the credibility of the central bank is being tested. "Any hesitation could weaken people's confidence in its ability to maintain price stability, and once this confidence is lost, it will be difficult to regain. In a world full of uncertainty, the European Central Bank needs to balance growth risks and inflation pressures, while reinforcing its commitment to financial and monetary stability."