The possible monetary policy scenarios for the major central banks, regarding the intensity and duration of inflationary pressures that may arise from disruptions in energy markets due to the geopolitical crisis in the Middle East and shipping disruptions in the Strait of Hormuz, according to an analysis by Eurobank’s Economic Analysis and Research Unit. The authors of the study are Marcus Bensasson, Research Economist, and Paraskevi Petropoulou, Senior Economist.
The critical question for central banks is not so much the magnitude of the rise in oil prices, but rather the duration of the increased energy costs. Specifically, monetary policy will depend largely on whether the increased energy costs prove to be persistent. These costs stem from natural gas prices, transportation costs, insurance premiums, and disruptions in supply chains.
It may prove persistent enough to feed into underlying inflation and destabilize inflation expectations. The baseline scenario envisages a gradual de-escalation of tensions through negotiation and a return to normality, though it does not rule out the persistence of some disruptions in energy markets and supply chains.
Under this scenario, oil prices may decline, but the slower normalization of transport and supply flows is expected to keep the costs of natural gas, transport, and insurance elevated. As a result, inflation is projected to remain above central banks’ targets for a longer period than initially anticipated.
Transmission channels
The energy shock is transmitted to the economy through three main channels: the direct effects of higher energy prices, the indirect gradual pass-through of increased production and transportation costs to final prices, and secondary effects through long-term inflation expectations and wages.
The ECB
At present, the direct effects are already evident, the cost pass-through is gradually strengthening, while the secondary effects have not yet materialized. The European Central Bank (ECB) is in the most difficult position compared to the other two major central banks. The eurozone’s high energy dependence and the experience from the 2021–2022 inflation cycle limit its ability to ignore the new energy shock.
The Fed
At the same time, the likelihood of widening sovereign debt spreads among member states and the uneven transmission of monetary policy limit the scope for a particularly aggressive tightening of monetary policy. The U.S. Federal Reserve (Fed) appears to have greater leeway to view the effects of the energy shock as temporary, as its energy position as a net exporter of oil and natural gas in recent years mitigates the negative effects of increased energy costs.
Bank of England
However, tariffs act as an additional source of inflationary pressures, complicating the assessment of the medium-term outlook for inflation. The Bank of England (BoE) is in an intermediate position between the Fed and the ECB. The adjustment of regulated energy prices in the third quarter is expected to mechanically boost inflation, while persistent price momentum in services increases the risk of second-round inflationary effects. As a result, the United Kingdom appears more exposed to the risk of inflationary pressures becoming entrenched compared to the Eurozone and the United States.