Lagarde: Energy shock demands data-driven policy response

ECB President Christine Lagarde highlighted the 'relentlessness' of recent global shocks, from the pandemic and a land war to the worst energy crisis in 50 years and sweeping tariff increases.

The latest military conflict has shut down the Strait of Hormuz, the world's most important energy chokepoint.

This has led to an estimated net loss of 13 million barrels per day of oil, roughly 13% of global consumption.

So far, energy prices have not pushed the euro area squarely into the ECB's adverse scenario, as markets appear to bet on a short-lived disruption.

European natural gas prices are even below the baseline, influenced by gas-to-coal switching in Asia and mild weather in China.

However, the outlook remains fragile, with worse paths still possible, especially if the disruption persists and affects critical inputs like helium, fertilisers, and methanol, potentially shifting from price adjustments to rationing and directly hitting output.

Setting monetary policy is challenging due to two critical uncertainties: the duration of the disruption and the pass-through of energy prices to broader inflation.

The longer the conflict lasts, the worse the economic outlook becomes, non-linearly.

Unlike 2022, when the shock's persistence was clear, today's outcomes are wider, with oil prices fluctuating with conflict developments.

The second factor is how energy prices transmit to broader inflation.

In 2022, strong demand and supply bottlenecks facilitated broad pass-through.

This time, 'muscle memory' from recent inflation could make households and firms more sensitive.

However, higher energy prices and weaker consumer sentiment could also weigh on demand, limiting price and wage increases.

The relative importance of these forces will only become clear with actual data on firms' pricing behavior and wage negotiations, arguing for gathering more information before firm monetary policy conclusions.