FRANKFURT — Geopolitics is colliding with monetary policy — and the European Central Bank is on the front line.

Just four years after inflation surged to nearly 10 percent, Europe is facing another oil-driven price shock and more are likely to follow. The trouble is that inflation is increasingly driven by wars and energy shocks that central banks have little control over.

“It is becoming increasingly difficult to achieve economic stability and growth through monetary and fiscal policy alone,” Bank of Korea Governor Rhee Chang Yong said in unusually candid remarks ahead of the end of his term this week.

His comments will resonate in Frankfurt, where ECB officials are grappling with the economic fallout from the Middle East conflict, which has sent fuel prices soaring.

Tehran’s effective closure of the Strait of Hormuz and attacks on oil infrastructure in the Persian Gulf, in response to the U.S.-Israeli airstrikes, have triggered the second energy crisis in four years. The ECB is on high alert to avoid the same mistake it made in 2022, when it first dismissed rising prices as a temporary issue on the back of Russia’s invasion of Ukraine.

The central bank had to raise the cost of borrowing in record time to make up for the error, as the initial price shock fed into wages and broader prices across the economy.

Today’s backdrop is less combustible than in 2022, when reopening demand, loose fiscal policy and ultra-low interest rates created ideal conditions for inflation to take hold. Acutely aware of the pain rate hikes will inflict on the already fragile economy, ECB policymakers are equally keen to avoid the mistake of unnecessary tightening.

“The ECB once again has the unenviable task of deciding whether to raise interest rates in the face of the worrying inflation picture, or whether this price spike will prove temporary and its focus should instead be on preventing the economy from sliding into a deeper downturn,” S&P Global Chief Business Economist Chris Williamson said on Thursday, after key economic survey showed that a toxic mix of stagnant growth and surging prices are squeezing Europe’s economy.

The trouble is that inflation is no longer primarily driven by an overheating economy that central banks can cool by hiking rates. Instead, it’s wars, trade tariffs and energy crises that are increasingly shaping prices. The Strait of Hormuz, through which 20 percent of the world’s oil and gas is shipped, is a case in point.

“The Strait of Hormuz is closing, then opening, and closing again,” ECB Vice President Luis de Guindos said earlier this week in Madrid. “It’s the main element that will shape the trajectory and expectations of inflation.”

That helps explain why the ECB has stayed deliberately vague on rate hikes, even as markets price in two increases this year. The ECB’s next policy meeting is on April 30. Most analysts expect it to hold off on any decision until the June 11 meeting, when new economic forecasts will be available.

Strategic autonomy

Prevailing uncertainty and the nature of the shocks may force the ECB to accept larger and more frequent swings in inflation than it has traditionally tolerated, or risk inflicting lasting damage on the region’s economic potential.

Hiking rates aggressively during a supply shock may not only engineer a short-term recession but also risk lasting damage, from weaker investment to lower long-term growth. As former U.S. Federal Reserve chair Ben Bernanke put it last year, central banks should not try to fully offset supply-driven inflation because it would be “too costly in terms of output and employment.”

The implication is uncomfortable, especially for the ECB, which has a single mandate to fight inflation, in contrast to other central banks, such as the U.S. Federal Reserve, which also targets maximum employment.

In a more fragmented world, raising rates to counter the fallout from a supply shock may prove costly. The real solution is to strengthen strategic autonomy by reducing reliance on foreign countries and supply chains that Europe cannot control. Recent crises have highlighted that “we are paying a very high price for our overdependency on fossil fuels,” European Commission President Ursula von der Leyen said last week.

Some economists have argued that, in this new reality, central bankers should avoid rate hikes until there is clear evidence that higher prices are feeding into wages. The ECB should wait until the end of the year so that it can make a more informed decision, Erik Nielsen, a senior adviser to Independent Economics, said in a recent Substack.

To ensure that people do not lose trust in the central bank’s commitment and ability to steer inflation back to target, policymakers need to be more candid about their ability to fine-tune price developments.

“Central bank communication should put greater weight on the possibility that outcomes can be quite different from the modal expectation; and that, if the reality is different from the forecast, monetary policy will respond appropriately,” Bernanke said.