Euro Inflation Notes: Energy variations
|With no end of the Russian-Ukraine war in sight, energy price developments will likely stay volatile, rendering any inflation predictions highly uncertain. Therefore, we look at some alternative scenarios how HICP inflation could evolve over the coming 12 months with (1) stronger and faster energy feed-through to consumer prices than historically and (2) with price caps for gas and electricity as currently discussed at the EU-level and for various EU countries.
Overall, we find that upside risks to euro area inflation exist in the magnitude of 2-4pp compared to our baseline HICP inflation projection and market pricing, if wholesale prices remain at current elevated levels and pass-through for gas and electricity prices happens faster than historically.
Our back of the envelop calculations (which disregard second round effects) suggest the downside risk to euro inflation from gas and electricity price caps is relatively limited and in the magnitude of 0.5-1pp compared to our baseline HICP inflation projection and market pricing. But the lack of clarity on the design and implementation of any caps, combined with the indirect effects of a weakening demand environment render any numerical estimates highly uncertain.
With the outcome span for euro inflation remaining unusually wide next year, policy makers such the ECB face a tough job in calibrating the right monetary policy stance, increasing the risk of policy mistakes.
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