War and price

Central banks should ignore soaring energy costs

But they must continue fighting home-grown inflation

War in Ukraine has caused European natural-gas prices almost to double and sent oil prices soaring to over $115 a barrel. That has added to the inflation problem facing the world’s central banks. And more pain is probably coming. Western energy giants are getting out of Russia, sanctions are wreaking havoc on Russian commodities exports and the cancelling of the Nord Stream 2 gas pipeline from Russia to Germany will remove a potential source of relief. If Russian energy exports are cut off completely, the oil price could reach $150, rapidly boosting global consumer prices by another 2%.

According to orthodoxy, rich-world central bankers should all but ignore supply shocks such as dearer energy. That is because their direct effect on inflation is only temporary. When policymakers ignore this rule of thumb things usually go wrong. In 2008 and 2011 the European Central Bank (ECB) raised rates because of supply-side factors, and ended up worsening the Great Recession and its aftermath.

But today’s shock comes as inflation is already too high. Central bankers are worried about prices taking on a momentum of their own. They may be reminded of the energy crisis in 1973, when the Yom Kippur war led to an oil embargo and a spike in prices that made a bad inflation problem worse.