European Central Bank economists Kristina Barauskaitė Griškevičienė and Claus Brand recently highlighted that rising energy prices are the primary force behind current inflation within the euro area. Their analysis suggests a distinct dynamic compared to previous inflationary periods, emphasizing that the current energy supply shock is the dominant factor, with demand-side pressures and public policy stimulus playing only minor roles. This differentiation, they argue, is crucial for understanding the ECB’s evolving monetary policy responses.
The present situation, exacerbated by the ongoing conflict in the Middle East and its potential impact on shipping routes like the Strait of Hormuz, bears little resemblance to the inflation surge observed in 2021-22. During that earlier period, a confluence of supply and demand factors fueled price increases. Global supply chain disruptions and energy supply shocks, particularly following Russia’s invasion of Ukraine, were significant supply-side contributors. Simultaneously, a rapid post-pandemic rebound in demand, bolstered by accommodative fiscal and monetary policies, created substantial demand-side pressure. While energy costs played a part then, it was not the exclusive driver.
In contrast, the current inflationary environment appears largely concentrated in the energy sector. Between January and May 2026, adverse energy supply factors alone accounted for approximately 90% of the increase in energy inflation. During this same timeframe, both monetary and fiscal policies have exerted only a slight dampening effect on energy prices. This singular focus on supply-driven energy costs presents a unique challenge for the ECB, necessitating a carefully calibrated approach to interest rate adjustments.
Following the outbreak of war in the Middle East at the end of February, the ECB initially held off on immediate rate increases. Its first hike, lifting the deposit rate from 2% to 2.25%, occurred on June 11, marking the first such increase in three years. This initial move aimed to temper inflation, yet even under the most optimistic projections at the time – which assumed a swift resolution to the conflict – inflation was not expected to return to the 2% target before 2027.
However, the conflict persists, and inflation figures continue to climb. August saw euro area inflation reach 3.3%, an increase from 2.9% in July. Market pricing now anticipates another rate hike from the ECB, with expectations for the deposit rate to rise from 2.25% to 2.50% at its upcoming meeting on September 10. The central bank has characterized its current monetary response as more “gradual” than the forceful and persistent rate increases implemented during the 2021-22 period, reflecting the differing nature of the underlying economic pressures. The distinction between a broad-based inflationary surge and one predominantly driven by a specific supply shock guides the institution’s strategy, aiming to address the core problem without unduly stifling other economic activity.
