Iran conflict drives supply‑shock inflation largely beyond ECB control

Brussels – “Energy prices are surging again, pushing up inflation in the euro area.” Experts at the European Central Bank want to set the record straight on this point. However, the rise in prices and the resulting cost-of-living pressures are beyond the ECB’s control. This is what emerges from the analysis, published on the ECB’s blog, of business expectations and perceptions of inflation. It is worth noting here that there is a difference between demand-driven inflation and supply-driven inflation. The main difference is that supply-driven inflation “is often caused by developments that are largely outside a central bank’s control,” which therefore has more limited room for manoeuvre. 

The ECB notes that price expectations among firms in the manufacturing, services, and construction sectors have “risen significantly” since the outbreak of war in Iran, and have since been “above pre-war level ever since.” In this case, firms interpret the situation as “largely stable demand-pull pressures,” thereby attributing the rise in prices to the supply side. In particular, the experts stress that “cost-push shocks drove up price expectations at the start of the war.”

What is worrying businesses, the ECB goes on to say, is primarily “materials supply shortages, linked to higher energy prices,” with consequent repercussions on production, particularly in energy-intensive sub-sectors such as chemicals, refined petroleum, and paper products. 

Compared with the start of the war in Ukraine and the situation that ensued in 2022, “the current rise in inflation has been driven, first and foremost, by a supply shock,” experts at the European Central Bank stress. The new inflationary spiral “has been fuelled by rising energy prices passing through the production chain, rather than by a broad-based surge in demand.” Businesses understand this. They have been paying increasing attention to inflation risks and inflation itself, and their demand expectations have remained flat.