The specter of inflation reappears, but the "script" has changed. Why won't the European Central Bank repeat the mistakes of 2022?

When facing the threat of inflation caused by yet another round of war, the European Central Bank is well aware that this situation may be markedly different, and that it is in a more advantageous position to respond. As tensions escalate in Iran and energy costs soar, it has once again spurred market speculation about interest rate hikes. Officials are keenly aware of the similarities to 2022 when the Russia-Ukraine conflict ultimately led to out-of-control consumer price inflation. However, the situation that President Lagarde and her colleagues are facing is largely different. This difference is reflected in both the current combination of monetary and fiscal policies, as well as in the economic situation and energy supply sources. Despite market speculation driven by the desire to avoid a repeat of the Ukraine crisis, which has forced the European Central Bank to examine the similarities and emphasized that they are prepared to take action, officials suggest that no action will be taken in next week's policy decision. Jan Hatzius, Chief European Economist at Goldman Sachs, said, "There are indeed some similarities with 2022, but there may be more and more significant differences. Therefore, developments in the situation need to be closely monitored, but there is no need to overly amplify this comparison at present." The shift in global expectations of interest rate hikes is increasing the sensitivity of central banks around the world to the possibility of continued inflationary impacts. Currently, expectations for rate hikes in Australia next week and potentially in Japan as early as April are forming or solidifying. During the Ukraine war shock, many central banks responded slowly, and the European Central Bank faced the most severe criticism for its actions lagging behind its peers. Hatzius said that this memory will serve as a reminder to policymakers, but it will not prompt them to act immediately. One key similarity to 2022 is that military actions have led to significant spikes in oil and natural gas prices, with crude oil prices surpassing $100 per barrel at one point. EU officials have warned that if this shock continues, it could lead to inflation rates exceeding 3% this year. However, the outlook does not envision energy costs in the region reaching the high levels seen in 2022, and the resulting consumer price peaks are expected to be much more moderate. For example, current electricity prices in Germany are only a small fraction of what they were during the worst period of Europe's largest economy in the past, and the same goes for natural gas prices. Luca Cazulani, strategy director at UniCredit, said, "In 2022, natural gas prices remained high for a long time, but given the now more diversified energy structure in Europe, this situation is unlikely to occur again. This will suppress inflationary pressure in relative terms." Consumer price growth started from a lower point. Before February 24, due to the surge in energy costs, economic disruptions related to the pandemic, supply chain interruptions, and fiscal and monetary stimulus measures prompted by the pandemic, the inflation rate in January 2022 had reached 5.1%. The latest reading is 1.9%, slightly below the European Central Bank's target of 2%, although potential price pressures and wage growth are still slightly higher than comfortable for officials. Paul Hollingsworth, director of emerging markets economics at BNP Paribas Markets 360, said the global macroeconomic backdrop is also significantly different, and the employment situation in Europe is not as dire as it was four years ago. In a report, he wrote, "The labor market is tight, but not overheated like it was back then." Debt-driven global fiscal policies were also aimed at quickly rebounding prices and growth from the pandemic. Today, aside from a spending spree in Germany on infrastructure and defense, the expansionary nature of budgets in various countries has diminished. David Powell and Simona Dele Giagie, analysts, said, "While we still believe the ECB Governing Council will remain on hold for the remainder of the year, we have eliminated the downside risk to forecasts that existed before the energy shock. That being said, the current situation is different from the natural gas shock in 2022, so the ECB has no reason to deviate from its 'preemptive' strategy - at least not yet." There are also stark contrasts in monetary policy. In early 2022, deposit rates were still negative (-0.5%), a super-loose setting aimed at stimulating inflation. The current benchmark rate is 2%, widely seen as neither restrictive nor stimulative to the economy, indicating that limited adjustments could begin to curb price growth. Previously, the central bank's hands were tied by its forward guidance commitments, which promised to end the large-scale asset purchases (quantitative easing) before considering raising borrowing costs. The situation is different now. Peter Kazimir, Governor of the Slovak Central Bank and member of the ECB Governing Council, said earlier this week, "If necessary, we can react more quickly. We must remain flexible. We have also learned from our mistakes." As the policy decision on March 19 approaches, policymakers emphasize that the duration of the war and the resulting spike in energy prices will determine the impact, and they are closely monitoring inflation expectations. While longer-term market indicators have risen, they are still far below the peak recorded in 2023. Jack Allen-Reynolds, Deputy Chief Eurozone Economist at Capital Economics, said the risk of a reprisal of the Ukraine crisis seems limited, but "it is easy to imagine a scenario where energy prices rise significantly further." Stefan Gerlach, former Deputy Governor of the Central Bank of Ireland, believes that in this situation, especially considering the impact of the Ukraine shock, policymakers, including the European Central Bank, will be more willing to respond. Gerlach, now Chief Economist at EFG Bank in Zurich, said, "Central banks will be much more alert this time. No central bank governor wants to have a record like 2022 on their resume."