ECB's Nagel warns inflation will stay 'significantly above target'

Inflation will probably remain well above the European Central Bank's target even after the U.S. and Iran agreed to end their war in the Middle East, Bundesbank President Joachim Nagel said Tuesday.

Speaking on the sidelines of the ECB's Forum on Central Banking in Sintra, Portugal, Nagel told CNBC that the energy price shock from the conflict is still working its way through the economy. "I suspect the inflation rate will stay significantly above our target," he said.

The warning from one of the ECB's most hawkish members lands as the central bank weighs its next move after cutting rates in June. Nagel's comments suggest the Governing Council will remain cautious about further easing. The energy shock may have faded from headline numbers, its second-round effects on wages and services prices are still feeding through.

Nagel did not specify a timeline for when inflation might return to the ECB's 2% goal. He said the probability of an extended period above target is high enough that the central bank cannot declare victory yet.

For traders, the message is straightforward. The ECB is unlikely to rush into another rate cut at its July 18 meeting. The deposit rate, currently at 3.75%, could stay there through the summer. Markets had priced in a second cut by September. Nagel's remarks push that timeline into doubt.

Bond yields reacted immediately. German two-year yields, the most sensitive to ECB policy expectations, rose 4 basis points after the interview crossed wires. The euro edged higher against the dollar, gaining 0.2% to $1.0730. A higher-for-longer rate path in Europe makes euro-denominated assets more attractive relative to dollar-denominated ones, at least until the Federal Reserve signals its own easing.

The transmission to risk assets is less direct but still material. European equities, particularly rate-sensitive sectors like real estate and utilities, face headwinds if the ECB holds rates steady. The STOXX 600 fell 0.3% in afternoon trade. Banks, by contrast, benefit from a wider net interest margin when the central bank keeps its policy rate elevated.

Nagel's warning also reinforces the divergence between the ECB and other major central banks. The Bank of England is expected to cut rates in August. The Fed is on hold but markets see a September cut as likely. If the ECB stays tight while others ease, the euro could strengthen further, putting pressure on European exporters.

The energy price shock Nagel referenced stems from the Middle East conflict, which disrupted oil and gas supplies earlier this year. Even with the ceasefire, some of those price increases have embedded themselves into contracts and supply chains. The pass-through to consumer prices takes months to fully materialize.

The ECB's next policy decision is due July 18. Nagel's comments suggest the hawks have enough ammunition to argue for patience. The doves, led by chief economist Philip Lane, will point to weak growth and argue that waiting too long risks undershooting the inflation target on the downside. The July meeting will test which side wins.

For now, the market is repricing. Rate-cut bets are being trimmed. The euro is firming. European bonds are selling off. Nagel's warning is a reminder that the inflation fight is not over, even if the war that helped ignite it has ended.