The head of the European Central Bank says that businesses may be quicker to raise prices in response to the oil shock from the Iran war due to bitter memories of the inflation spike after Russia’s invasion of Ukraine in 2022.
If oil and gas prices continue to rise, “the response of firms and workers may be faster than last time,” ECB President Christine Lagarde said Wednesday in the text of a speech at a conference in Frankfurt, Germany.
“We have a more recent memory of high inflation, which could affect how quickly costs are passed on and compensation is sought,” Lagarde said.
Even though the ECB brought the 2022 inflation spike under control with higher interest rates, “that experience has left a mark,” she said. “An entire generation has now lived through its first episode of high inflation — and it may not be as slow to react a second time.”
Inflation in the countries that use the euro currency peaked at 10.6% in October 2022 after the invasion led to the cutoff of most Russian natural gas supplies and sent oil prices temporarily higher. Inflation in February was 1.9%, according to EU statistics agency Eurostat.
Lagarde pointed out that monetary policy cannot lower oil prices, and that central banks typically look past transitory energy spikes without raising interest rates. Raising rates only makes sense if higher energy prices start being built into prices for other goods and into workers’ wages, producing a price spiral.
“If the energy shock is seen to be limited in size and short-lived, the classical prescription of looking through should apply,” she said, because by the time rate hikes take effect with a lag of months, the inflationary spike is already gone.
Central banks typically raise rates to fight inflation. That cools price increases by raising borrowing costs for things like house mortgages or building new production facilities.
She said there were reasons to think the current jump in oil prices might be less inflationary than feared, because the energy price spike is, so far, smaller than the one Europe experienced in 2021-2022.
But if inflation appears to be heading persistently above the ECB’s 2% target, “the response must be appropriately forceful or persistent.”
Lagarde said it was “too early to say where in this spectrum we will need to be. … We will monitor developments closely and set monetary policy as appropriate.”
The ECB left its key interest rate unchanged at 2% at its last policy meeting March 19.
McHugh writes for the Associated Press.
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