Europe Avoids Inflation Shock, Markets Overreact to Rate Hikes

Europe's inflation shock has been significantly milder than expected, according to ING economist James Smith. Despite the Iran War and disrupted energy routes through the Strait of Hormuz, growth has held together and inflation has not taken flight.

The stagflation forecasts that arrived after the war began have quietly been folded away, as markets have moved beyond pricing resilience and now price at least two additional rate hikes from both the European Central Bank and the Bank of England.

Smith's research suggests that this may be confusing an economy relieved by contained inflation with one strong enough to require substantially tighter monetary policy. Europe is not necessarily running hot, but rather has avoided freezing due to a smaller energy shock.

The energy contribution to eurozone inflation has decreased significantly, from approximately four percentage points in July 2022 to less than one quarter of that amount today. The current energy shock remains meaningful, but it has not approached the force of the one that followed the Ukraine invasion.