How will the central bank respond to rising energy prices?

Investing.com - The European Central Bank and the Bank of England are expected to keep current interest rates unchanged while issuing hawkish guidance to address a new wave of energy-driven inflation.

Explore how the Iran war affects global markets - InvestingPro

According to the latest analysis from UBS Group (NYSE:UBS), policymakers are shifting their focus to the “second-round” effects of rising fuel prices, particularly inflation expectations, rather than responding to the initial price shock.

The market currently anticipates multiple rate hikes in 2026, but analysts believe that a more cautious “wait-and-see” strategy may be the more likely path for the Eurozone and the UK.

Fiscal Firepower vs. Monetary Policy Vigilance

Central banks are walking a tightrope between stubborn inflation and avoiding severe damage to medium-term growth. UBS points out that higher inflation itself indicates a slowdown in economic expansion, but due to massive fiscal expansion, the economic downturn in 2022 may not be repeated.

The scale of this “fiscal firepower” is unprecedented since the pandemic and is expected to support demand and shield major economies like Germany from the full impact of soaring energy prices. Therefore, the European Central Bank and the Bank of England may continue to express a readiness to act without prematurely tightening policies during an economic slowdown.

The resilience of the European economy is also attributed to the structural shift in energy consumption. Since the crisis in 2022, various sectors have partially reduced their dependence on imported natural gas through significant investments in solar energy, wind energy, and heat pumps.

Additionally, as the service sector occupies a larger share of output and electric vehicles currently account for 20% of new car registrations, the energy intensity of the economy has decreased. These efficiency gains indicate that while the region still faces the risk of soaring global market prices, it is better prepared to absorb the current shocks compared to previous cycles.

Strategic Resilience and Industrial Transformation

Market attention is focused on the least productive manufacturing sectors, which have seen a decline in output, although the overall gross value added remains relatively stable. Investors are also closely monitoring the April 6 deadline related to the Iran conflict, which may determine the duration of the current energy premium.

As long as the second-round inflation effects remain manageable, a hawkish wait-and-see strategy is expected to continue, providing a stable yet restrictive backdrop for European equities in the first half of the year.

This article was translated with the assistance of artificial intelligence. For more information, please see our terms of use.