Schnabel: Energy shock fuels inflation, higher rates expected

Isabel Schnabel, Member of the Executive Board of the European Central Bank, warned that the recent energy shock, primarily from the gradual reopening of the Strait of Hormuz, is expected to keep oil prices persistently higher.

This geopolitical event, alongside the Iran war, has led Eurosystem staff projections to forecast lower euro area GDP growth and higher HICP inflation for 2026-2028.

While a peace deal announcement on June 12, 2026, made some negative scenarios less likely, uncertainty remains high for both oil and gas prices.

The energy shock has hit the euro area particularly hard, but its impact is less severe than in previous oil price shocks due to reduced oil intensity of real GDP.

Schnabel highlighted that higher energy costs transmit to broader inflationary dynamics through direct effects, indirect cost effects, and second-round effects on wages and pricing, reinforced by supply chain pressures.

Higher energy costs are already weighing on consumer confidence and private consumption, with changes in nominal consumption growth observed across various goods categories.

However, euro area growth is finding support from government investment, particularly in Germany's defence and infrastructure spending, and a global AI boom reflected in firms' earnings expectations.

The labor market remains resilient, characterized by a cooling in labor demand but persistent tightness in supply, as indicated by factors limiting production.

Despite this resilience, food, goods, and services inflation continue to face upside risks, driven by knock-on effects from energy prices and ongoing supply chain pressures, which producers are partly passing through to output prices.