The European Central Bank (ECB) is facing a familiar challenge as a geopolitical conflict threatens to reignite inflation.
At the heart of the issue is the ongoing conflict in the Middle East, which began in late February and has intermittently disrupted the critical Strait of Hormuz. This has caused significant volatility in energy markets, with Brent crude oil prices spiking as much as 72% above pre-war levels. This is a classic supply shock, where a sudden reduction in the supply of a key commodity pushes prices up sharply across the economy. The direct impact was seen immediately in the Eurozone's April inflation figures.
First, the data clearly showed the problem. The Harmonised Index of Consumer Prices (HICP), the Eurozone's main inflation gauge, jumped back to 3.0% in April, up from 2.6% in March. The cause was unmistakable: the energy component soared by 10.9% year-over-year. This is precisely the scenario that ECB Governing Council member Joachim Nagel warned about. He stated that the longer the conflict continues, the greater the risk that these high energy costs will 'seep into' other parts of the economy.
Second, this 'seeping' process is known as second-round effects. It happens when businesses, facing higher energy and transport costs, raise the prices of their goods and services. Workers might then demand higher wages to cope with the rising cost of living, creating a cycle of price and wage increases. The ECB's primary concern is preventing this cycle from taking hold and de-anchoring inflation expectations. This is why, despite holding its key interest rate at 2.00% in its April meeting, the bank explicitly highlighted the upside risks to inflation and kept the option of a future rate hike on the table.
However, Nagel also pointed out a crucial difference from the 2022 inflation surge: a 'better starting position'. Unlike in 2022, when inflation was already high and rising, the ECB entered this shock with core inflation (which excludes volatile energy and food prices) near its 2% target and long-term inflation expectations well-anchored. This gives the bank more credibility and a bit of time to assess whether the energy shock will be temporary or persistent before taking action.
- HICP (Harmonised Index of Consumer Prices): A measure of inflation across the Eurozone countries, compiled in a standardized way to allow for comparisons.
- Second-round effects: The indirect impact of a price shock, where initial price rises (e.g., in oil) lead to increases in wages and other goods and services, causing inflation to become more widespread and persistent.
- Supply shock: An unexpected event that suddenly changes the supply of a product or commodity, resulting in a sudden change in its price.