By David Barwick – VIENNA (Econostream) – De Nederlandsche Bank Executive Board member Bas ter Weel on Thursday said last week’s 25bp rate hike by the European Central Bank reflected increased upside risks to medium-term inflation and evidence that the latest energy shock was becoming more persistent and broad-based.

Ter Weel, who is responsible for monetary affairs at the DNB and is deputy to the Dutch governor on the ECB’s Governing Council, said in a speech at a conference organized by the Austrian National Bank and SUERF that central banks could not always look through supply shocks.

“This decision reflects the assessment that upside risks to medium-term inflation have increased,” he said of the ECB’s move last week to raise all three key rates by 25bp.

“Specifically, incoming information suggests that the recent energy shock may prove more persistent than previously expected and that its effects are increasingly feeding through to broader inflation,” he said.

Energy prices, “and oil prices in particular,” had been revised upward across the projection horizon compared with the March forecasts, implying that energy-related price pressures were “likely to remain present for longer,” he said.

Core inflation had also been revised upward and was expected to continue increasing gradually over coming quarters, with the peak expected only in early 2027, he said.

“This suggests that the effects of the shock are increasingly transmitting through the broader economy,” he said.

Ter Weel said the textbook prescription was to look through small and temporary supply shocks, but that there were limits to this approach.

“The recent inflation surge in the euro area illustrates that when a shock becomes more persistent and broad-based, a swift pivot of the policy stance may be necessary,” he said.

In the case of structural shocks, the case for looking through inflation pressures was weaker, he said. Monetary policy could not offset a decline in potential output without generating excessive inflation, he said.

Scenarios in which energy prices remained higher for longer should not be discounted, despite the recent decline in oil prices in response to the prospect of further negotiations, he said.

The Eurosystem’s latest projections included severe, adverse and milder scenarios for energy prices, he said.

“These scenarios, together with the Governing Council’s data-dependent approach and readiness to act, serve to make our policy choices more robust against uncertainty,” he said.

Even temporary shocks could have persistent effects depending on their transmission through production chains, Ter Weel said.

Global supply-chain shocks had a “positive and persistent effect on core inflation,” and the peak effect on inflation came only months after the initial shock, he said.

“[E]ven in a benign scenario where energy prices return to normal relatively quickly, their impact on broader inflation may last considerably longer,” he said.

Last week’s rate hike was also underpinned by the assessment that higher energy prices were feeding into broader inflation to some extent and that spillovers could be higher than expected, he said.

Supply shocks could have stronger effects when inflation was already high, Ter Weel said, because firms changed prices more often in such an environment.

“[F]or a given supply shock, the effects on inflation and output are much higher, when inflation is already high,” he said.

Linear models often used by policymakers could therefore underestimate the amplification of such shocks, especially with inflation having only recently declined from elevated levels, he said.

At the same time, more flexible prices also made monetary policy more potent, Ter Weel said.

“In other words: the risks of an acceleration of inflation are higher, but the tools to push back are also more powerful,” he said.

Taken together, recent developments “underpinned the case for a measured adjustment of the monetary policy stance,” he said.

“At the same time, the Governing Council remains data dependent and stands ready to adjust the policy rate to deliver 2% inflation over the medium term,” he said.