Senior economists at the European Central Bank published a blog post on Wednesday, cautioning that it cannot be assumed the current inflationary shock in the eurozone will be milder than the one in 2022, with several fundamental leading indicators suggesting significant upside risks to inflation.
Driven by the conflict in Iran pushing up energy prices, inflation in the eurozone surged to 3.2% in May, significantly exceeding the 2% policy target, with energy price increases now transmitting through the services sector to the entire industrial chain.
The market widely expects the European Central Bank to implement a modest interest rate hike this month, but most institutions predict there will be no aggressive tightening of monetary policy thereafter, citing the current environment as unlikely to trigger rapid and sharp price increases.
The blog's authoring team includes Oscar Arce, Head of the ECB's Economic Department. The authors acknowledge the aforementioned fundamental constraints but indicate that upside and downside risks to inflation have become more balanced.
The views in the blog do not represent the official stance of the European Central Bank. The post states: "Some factors make current inflation risks lower than in 2022, but several pre-existing conditions mean the inflationary threat this time around could actually be greater than back then."
Factors Contributing to Lower Inflation
The current price shock is primarily concentrated in the crude oil category; natural gas prices are significantly lower than the same period in 2022, and coupled with the adoption of renewable energy, electricity prices remain stable. Weakening consumer demand, a cooling labor market, and fiscal and monetary policies that are generally tighter than at the beginning of the previous crisis all serve to constrain runaway inflation.
Risks That Could Push Inflation Higher
The current energy shock has a stronger global dimension compared to 2022. Should the magnitude, scope, and duration of the shock exceed market expectations, it could easily trigger a non-linear acceleration in inflation.
The authors explain: "A global shock pushes up costs extensively along global value chains, indirectly exerting a stronger pull on inflation. This amplifies the rise in import prices and significantly strengthens the transmission of energy price increases to the domestic real economy."
Furthermore, having experienced the previous round of sharp price increases, households are more prone to quickly forming high inflation expectations. Additionally, fiscal buffers for national governments have shrunk considerably compared to that time, making it difficult to use fiscal subsidies to curb price rises.
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