The Ghost of Inflation Returns but the "Script" Has Changed, Why the European Central Bank Won't Repeat 2022's Mistakes

As Europe faces another wave of inflation triggered by war, the European Central Bank (ECB) is aware that this situation could be quite different and that it is in a better position to respond.

With tensions in Iran escalating and energy costs soaring, market bets on interest rate hikes have reemerged. Officials are keenly aware of the similarities to 2022, when the Russia-Ukraine conflict ultimately led to runaway consumer price growth.

However, the situation faced by President Lagarde and her colleagues is largely different. These differences are reflected not only in the current mix of monetary and fiscal policies but also in economic conditions and energy supply sources.

Although market expectations driven by fears of repeating Ukraine’s crisis have prompted the ECB to consider similarities and emphasize its readiness to act, officials have signaled that no action will be taken in next week’s policy decision.

Goldman Sachs Chief European Economist Jari Stehn said, “There are some similarities to 2022, but there are likely more and more significant differences. Therefore, recent developments should be closely watched, but there’s no need to overstate this comparison at the moment.”

The shift in global rate hike expectations is increasing sensitivity among central banks worldwide to the potential persistence of inflation shocks. Currently, markets are forming or strengthening expectations of an interest rate hike in Australia next week and possibly Japan as early as April.

During the Ukraine war shock, many monetary authorities responded slowly, and the ECB faced harsh criticism for acting even later than its peers. Stehn notes that this memory will serve as a reminder to policymakers but will not prompt immediate action.

A key similarity to 2022 is that military actions have caused sharp rises in oil and natural gas prices, with crude oil briefly surpassing $100 per barrel. EU officials warn that if these shocks persist, inflation could exceed 3% this year.

However, this outlook does not assume energy costs will reach the highs seen in 2022, and the peak in consumer prices is expected to be much milder. For example, electricity prices in Germany are currently only a small fraction of what they were during the country’s most severe period that year, and natural gas prices are similarly lower.

Luca Cazzulani, Head of Strategy at UniCredit, said, “In 2022, natural gas prices remained high for a long time, but given Europe’s more diversified energy mix now, such a situation is unlikely to recur. This will relatively restrain inflationary impulses.”

The starting point for consumer price growth is also lower. Before February 24, 2022, inflation had already reached 5.1% in January, driven by soaring energy costs, pandemic-related economic disruptions, supply chain interruptions, and fiscal and monetary stimulus measures. The recent reading is 1.9%, slightly below the ECB’s 2% target, though potential price pressures and wage growth remain somewhat above comfort levels for officials.

Paul Hollingsworth, Head of Developed Markets Economics at BNP Paribas Markets 360, noted that the global macroeconomic environment is also significantly different, and Europe’s employment situation is less severe than four years ago. In a report, he wrote, “The labor market is tight but not overheating as it was back then.”

Debt-driven global fiscal policies aimed at quick economic rebound from the pandemic have also shifted. Today, apart from Germany’s infrastructure and defense spending boom, fiscal expansion has slowed in many countries.

Analysts David Powell and Simona Dele Kiyaye said, “While we still expect the ECB Governing Council to hold steady for the rest of the year, we have eliminated the downside risks that were common before the energy shocks. That said, this round is different from the 2022 natural gas shock, so the ECB has no reason to deviate from its ‘look-through’ strategy—at least for now.”

Policy rate settings also differ markedly. In early 2022, deposit rates were still negative (-0.5%), a highly accommodative stance aimed at boosting inflation. Currently, the benchmark rate is 2%, widely seen as neither restraining nor stimulating the economy, meaning limited adjustments could start to curb price increases.

Previously, the ECB’s actions were also constrained by forward guidance commitments, which promised to halt large-scale asset purchases (quantitative easing) before raising borrowing costs. That is no longer the case.

Peter Kazimir, Governor of the Slovak Central Bank and a member of the ECB Governing Council, said earlier this week, “If necessary, we can respond more quickly. We must remain flexible. We have also learned lessons.”

As the March 19 policy decision approaches, policymakers emphasize that the duration of the war and the resulting energy price surges will determine the impact, and they are closely monitoring inflation expectations. Market-based longer-term indicators have risen but remain well below the peaks seen in 2023.

Jack Allen-Reynolds, Deputy Chief Eurozone Economist at Kantar Macro, said the risk of a repeat of the Ukraine crisis scenario appears limited, but “it’s not hard to imagine a scenario where energy prices rise significantly further.”

Former Deputy Governor of the Central Bank of Ireland, Stefan Grach, believes that in such circumstances—especially considering the memory of the Ukraine shock—policy makers, including the ECB, will be more willing to respond. Grach, now Chief Economist at Zurich’s EFG Bank, stated, “This time, central banks will be more cautious. No central bank governor wants to have a record like 2022 on their resume.”