Euro area – a 2022-style inflation shock?

Fears of a surge in inflation like in 2021/22

Since the attack of the U.S. and Israel on Iran, energy prices have risen sharply. As a result, the inflation rate in the euro aresa is likely to rise significantly in March. At around 2.5%, we estimate it will once again exceed the ECB’s 2% target.

For many, this brings back memories of 2021 and 2022, when the inflation rate spiked due to sharply rising energy prices. At the end of 2022, the inflation rate even briefly reached double digits. The ECB responded to this surge in inflation with sharp interest rate hikes starting in mid-2022. How great is the risk that this scenario will repeat itself?

The clearest parallel: significantly higher energy prices

The sharp rise in energy prices is the strongest parallel to the developments back then. A considerable share of this increase materialized as early as 2021, that is, before Russia’s attack on Ukraine. This was because demand for energy, recovering after the COVID-19 slump, met with supply that was still constrained. Added to this were initial restrictions on gas supplies from Russia. As Russia’s attack became increasingly likely, natural gas prices in particular rose sharply.

So far, the rise in gas prices in particular has remained well below that three and four years ago, but this could change in the coming months depending on the course of the war and the situation in the Strait of Hormuz. The impact of higher energy prices on consumer prices will also depend on whether governments or the EU intervene to curb the rise in prices. Italy and Spain have already pledged temporary measures.

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