Higher energy prices can put pressure on household budgets and business costs across the euro area. However, rising energy bills do not automatically lead to a lasting acceleration in overall inflation.
The key question for monetary policymakers is whether the initial increase spreads into other prices, wages and inflation expectations.
<h3>Energy Costs Have Not Fully Spread Through the Economy</h3>
Energy prices affect inflation directly through items such as electricity, natural gas and transport fuel. They can also influence the wider economy when companies pass higher production, shipping and operating expenses on to customers. The second stage of this process is known as a second-round inflation effect. It occurs when an initial price shock begins to influence other prices and wages, potentially making inflation more persistent than the original increase alone would suggest.
For example, a manufacturer facing higher electricity and transport bills may raise the prices of finished goods. Employees may subsequently seek higher wages to recover lost purchasing power, while service providers may adjust fees to cover increased expenses. When these responses become widespread, inflation can extend beyond the energy sector.
Lane said strong second-round effects had not yet become apparent, although the ECB continued to monitor the situation. Energy prices were higher than anticipated in the central bank's baseline outlook, but the extent to which those costs would spread through the wider economy remained uncertain.
<h3>Why the Inflation Outlook Remains Uncertain</h3>
Inflation forecasts depend on several assumptions, including future energy prices and the speed at which higher costs affect consumer prices and economic activity. Different combinations of these factors can produce substantially different outcomes.
A temporary increase in energy prices may cause a short-lived rise in headline inflation before the effect fades. A more persistent shock could create broader price pressures, particularly when businesses repeatedly adjust prices or wage negotiations incorporate expectations of continued inflation.
This distinction matters because central banks generally look beyond individual price movements when assessing whether inflation is becoming entrenched. Policymakers must consider both the latest data and the mechanisms that could carry price increases into subsequent months.
Lane cautioned against placing current conditions too quickly into either the ECB's baseline or adverse scenario. Such scenarios are analytical tools designed to illustrate possible paths, rather than definitive descriptions of how the economy will develop.
<h3>Wages, Services and Consumer Expectations Matter</h3>
Energy prices alone cannot determine the future direction of inflation. Wage growth, service-sector prices, business margins, consumer demand and inflation expectations all influence whether an initial shock becomes more persistent. Wages are particularly important because labour expenses represent a substantial portion of costs in many service industries. When pay increases outpace productivity growth for an extended period, companies may face pressure to raise prices.
However, wage increases do not necessarily translate into equivalent price increases: businesses may absorb some costs through lower margins or offset them with productivity improvements.
Consumer expectations also play a role. When households and businesses anticipate continued inflation, their spending, pricing and wage-setting decisions can reinforce existing pressures. Conversely, stable expectations can help prevent a temporary shock from becoming embedded in the wider economy. The ECB therefore needs to examine a broad range of indicators rather than treating elevated energy prices as sufficient evidence of a lasting inflation cycle.
<h3>Implications for ECB Monetary Policy</h3>
The absence of strong second-round effects provides an important distinction for policymakers, but it does not remove the risk of further inflation. The outlook could still deteriorate if energy prices remain elevated or their impact spreads more widely than expected.
At the same time, monetary policy operates with a delay. Higher interest rates can restrain demand and limit the ability of companies to pass on costs, but they can also weaken investment and economic activity. Policymakers must weigh the risk of persistent inflation against the possibility that tighter financial conditions will slow growth more sharply than anticipated.
<h3>Expert Insight</h3>
Philip Lane, chief economist and member of the ECB's Executive Board, explained why the current evidence does not yet support a firm conclusion about the broader impact of energy prices: “We have not seen, so far, very strong second round effects. We continue to look at them.”
The distinction between a temporary energy shock and persistent economy-wide inflation will remain important for monetary policy. Future decisions will depend on whether broader price pressures emerge, how expectations develop and whether economic activity can absorb higher costs without generating a lasting inflation cycle.
