ECB chief economist sees persistent impact on inflation from Iran war

TOKYO – The energy shock caused by the Middle East conflict will likely have a persistent impact on inflation even if there is a quick solution to the war, the European Central Bank’s (ECB) chief economist, Dr Philip Lane, said on May 28.

While oil prices historically tended to revert to original levels after a burst of increases, the current episode may be different as energy costs may stay elevated, with countries restocking inventory or diversifying their energy mix, he said.

“We had an overnight, fairly quick and big decline in global oil supply, which has been masked until now by inventories,” Dr Lane said at a conference hosted by the Bank of Japan and its think-tank in Tokyo.

“Even if the initial energy shock starts to reverse, the second round (effects) will be with us for a while,” he said.

With the energy shock pushing up prices, financial markets have fully priced in two hikes in the ECB’s 2 per cent deposit rate and see a roughly 50 per cent chance of a third move over 2027. Economists are more cautious and see just two hikes, followed by a cut in mid-2027, a Reuters poll showed.

Dr Lane said there could be some policy lessons from past energy shocks, such as that rising energy costs could push up inflation abruptly and cause “all sorts of non-linear” mechanisms that broaden price hikes.

“But it’s not the same non-linearity we had four years ago,” he said, referring to when supply disruptions from the Ukraine war and strong demand from the Covid-19 reopening pushed up inflation.

Central banks must acknowledge any substantial shocks and their potential impact on inflation, but avoid overreacting in setting monetary policy, Dr Lane said.

“You have to be skilful in terms of looking at monetary transmission, consumer confidence and all these different mechanisms,” he said.

While some inflationary pressures from a supply shock do calm down over time, it is important for central banks to make sure “there’s no persistent belief in the population or among price-setting sectors that inflation is going to be too high for too long”, he said. REUTERS