A global energy shock could amplify Eurozone inflation by more than 3 times the impact of a regional event, the European Central Bank’s chief economist warned, signaling a greater need for rate hikes.
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ECB signals inflation risk from global energy shock is 3 times worse
(P1) The European Central Bank’s chief economist Philip Lane warned Wednesday that the global nature of the current energy shock could make its inflationary impact on the eurozone more than three times larger than a regional price spike, increasing the case for a rate hike as soon as June.
(P2) "A global shock means that costs are increasing around the world," Lane said in a speech in London. "This creates a compounding effect where the final price of a good reflects not just the direct increase in the local energy price but the cumulated effects of price increases across international suppliers."
(P3) The warning comes as markets price in a series of hikes to the ECB’s key interest rate, currently at 2 percent, beginning with a well-telegraphed move in June. While the immediate impact on inflation has been "relatively contained," Lane noted that an ECB model simulation showed a 10 percent rise in global energy costs could add 1.5 percentage points to inflation over three years, compared to just 0.4 points from a regional shock like the one following Russia's 2022 invasion of Ukraine.
(P4) The analysis frames the ECB's upcoming decision as a difficult judgment call between slowing growth and persistent inflation. While higher energy prices will likely cause some demand destruction, the global pass-through of costs and the risk of higher wage demands may force the central bank into a more forceful and persistent policy response than previously expected.
Global Shock, Compounded Effects
The latest jump in oil and natural gas, triggered by the conflict in the Middle East, has drawn comparisons to the 2022 energy crisis. However, Lane detailed a crucial difference. In 2022, Europe was the epicenter as its Russian gas supplies were cut. In 2026, the shock is global, with Asian economies heavily reliant on energy imports through the now-disrupted Strait of Hormuz.
Because these economies produce many inputs and finished goods consumed in Europe, price increases to cover their higher energy costs are passed down the supply chain. "Even if the broader propagation of the shock might be more contained than in 2022, it may be stronger and faster compared to historical averages," Lane said.
Path to a Rate Hike
The ECB left its key interest rate unchanged at 2 percent in April, a level it has maintained as it assesses the economic outlook. However, Lane's comments are the latest in a series from policymakers laying the groundwork for a more hawkish stance.
A recent Reuters poll of economists aligns with market expectations, forecasting a rate hike in June and at least one additional increase before the end of the year. Lane acknowledged that while the "demand destruction" from higher prices could limit the amount of tightening required, the risk of second-round effects on wages and inflation expectations could necessitate a "forceful or persistent" response.
"Clearly, determining the appropriate monetary policy stance under these complex conditions is a judgment call,” Lane concluded. The Governing Council's next policy decision is scheduled for June.
This article is for informational purposes only and does not constitute investment advice.
