As the US and Israel’s war with Iran enters its second month, central banks can no longer just throw their hands in the air and say, “it’s all just too uncertain and complicated”. Even if the US unilaterally declares victory and departs, as each day passes with the Strait of Hormuz closed, it becomes less likely that this will be a short, sharp shock, with energy prices reverting to normal within weeks. The time is ripe, therefore, for central banks to set out a broad plan of action.
The European Central Bank has shown the way. The easy part for Christine Lagarde, its president, was to pledge to remain agile and guided by the data. More interesting was the three-pronged strategy she outlined.
The ECB would ignore a short energy price shock because it cannot affect oil and gas prices directly and the effects of any monetary policy change would arrive too late, she said; it can adjust rates a little higher if the shock has a similar effect on oil and gas prices as currently predicted by futures markets; and it would be prepared to act forcefully if high inflation showed signs of persisting. Unlike in 2022, the explicit goal is to ensure a rise in inflation will be transitory rather than simply predicting that as the outcome.