The European Central Bank (ECB) has signaled that it sees no immediate need to panic about the recent spike in inflation.
At first glance, the numbers are concerning. Euro area inflation re-accelerated to 3.2% in May, which is significantly above the ECB's 2% target. This increase was largely driven by a sharp 10.9% jump in energy prices, a direct consequence of geopolitical tensions that have pushed oil prices up nearly 40% since February. This is what economists call a 'first-round effect'—a direct price shock from an external source.
The key question for the ECB, however, is whether this will trigger a more dangerous 'second-round effect'. This happens when rising prices lead workers to demand higher wages to protect their purchasing power. In response, companies raise their prices further to cover the higher labor costs, creating a self-reinforcing loop known as a wage-price spiral. Such a spiral can entrench high inflation for a long time.
Fortunately, the ECB believes this isn't happening yet. The central bank's reasoning is based on a few key data points. First, the ECB's own wage tracker shows that negotiated wage growth is actually moderating, expected to be around 2.3-2.6% this year, down from over 3% last year. This directly contradicts the idea of an impending wage spiral. Second, recent economic activity surveys like the PMI show the services sector is contracting. While companies report higher costs, the slowing economy makes it difficult for them to pass on large price increases to consumers.
This is why ECB board member Frank Elderson recently stated the bank does not yet see second-round effects taking hold. This message, consistent with previous statements from President Lagarde, is a deliberate communication strategy. It signals that the ECB is vigilant and data-dependent, but not ready to react aggressively to what it currently views as a temporary energy shock. This cautious stance preserves flexibility ahead of the critical June policy meeting, where the bank must balance the risk of high inflation against the danger of stifling a fragile economy.
- Second-round effects: Also known as a wage-price spiral, this is a dangerous feedback loop where rising prices lead to higher wage demands, which in turn lead to even higher prices.
- PMI (Purchasing Managers' Index): A key economic indicator based on surveys of businesses. A reading below 50 suggests the economy is contracting, while a reading above 50 indicates expansion.
- HICP (Harmonised Index of Consumer Prices): The main measure of inflation in the Euro area, used by the ECB to guide its monetary policy.