Rebound in energy prices weakens Euro Area inflation improvement; ECB may still hike again in September

Overview

This report discusses the tug-of-war shaping the Euro Area inflation outlook between two forces: on one hand, recent inflation data in Europe and globally have been soft, while price surveys such as the PMI and those of the European Commission have started to cool; on the other hand, the resumption of military conflict in the Middle East and refinery shutdowns in Russia have pushed up crude oil, refined product, and natural gas prices, reintroducing energy price pressure. Goldman Sachs uses a large BVAR model to assess how energy shocks transmit along the inflation chain and to quantify the implications for the ECB policy path.

Core views

The core conclusion is that the rebound in energy prices has largely offset the recent improvement in Euro Area inflation. The model shows that energy shocks typically first affect consumer and producer energy prices directly, then gradually feed through to cost indicators, short-term inflation expectations, and consumer prices affected indirectly, and only eventually may show up in wages and long-term inflation expectations as second-round effects. In the current sample, direct effects were significant in March, some indirect effects accumulated in April, but weakened by June; as of the report date, there is no convincing evidence of second-round effects. Even so, the rebound in energy forward prices has been enough to bring the peak inflation forecast back close to the ECB staff baseline, supporting the view of another rate hike in September.

Analysis framework

The report uses a large Bayesian vector autoregression model jointly modeling 19 variables, including world oil production, Brent oil prices, TTF natural gas prices, European diesel prices, HICP energy, PPI energy, farm-gate prices, PPI intermediate goods, PMI input and output prices, 12-month consumer inflation expectations, HICP non-energy industrial goods, HICP food, average inflation forecasts over seven quarters, negotiated wages, HICP services, the PMI composite output index, the unemployment gap, and the global supply chain pressure index. The model includes six lags for each variable, the sample starts in 2003, and it compares counterfactual paths without the Middle East war against inflation paths conditional on energy shocks.

Methodology notes

• Macroeconometric ModelBayesian Vector Auto-Regression

  A large BVAR is used to estimate the dynamic transmission of energy shocks through the inflation chain.

  The autoregressive structure allows rich dynamic relationships among variables, while Bayesian estimation improves result stability; the report uses the model to jointly analyze energy, prices, inflation expectations, wages, and macro control variables.

• Scenario AnalysisNo-war counterfactual and conditional forecasts based on energy forwards

  Compares the no-Middle East war counterfactual path, the actual energy shock path, and inflation forecasts under different energy forward price assumptions.

  The no-war counterfactual uses realized data through February 2026 to form an unconditional forecast; the energy shock path is instead conditioned on changes in oil production, oil prices, gas prices, and diesel prices from March to June 2026.

• Shock IdentificationSign Restriction Identification

  Uses sign restrictions on oil production and oil prices to identify oil supply shocks, and applies zero sign restrictions to natural gas and diesel price shocks.

  The report uses heat maps to show the historical response strength and lags of different price indicators to oil supply, natural gas price, and diesel price shocks.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• Euro Area Rates

  Rising energy prices lift inflation forecasts and increase the probability of further ECB hikes or a prolonged period of high rates.

  Strengths

  The peak inflation forecast has returned near the ECB baseline, reinforcing near-term upward pressure on policy rates.

  Weaknesses

  Second-round effects are still not obvious; if energy prices fall back, the case for sustained tightening may weaken.

  Comparison

  Compared with the end-June low energy forward price scenario, the current energy price scenario is more hawkish for rates.

  Risks

  Persistently elevated energy prices could lead markets to reprice more hikes; if growth weakens quickly, policy room may become constrained.

• Energy Commodities

  Crude oil, natural gas, and diesel prices are the main drivers of changes in the inflation path in the report.

  Strengths

  The Middle East conflict and Russian refinery disruptions raise supply-side risk premia.

  Weaknesses

  The transmission of price shocks to core goods and wages is currently below or no stronger than historical experience.

  Comparison

  After rebounding from end-June lows, energy forward prices led to a significant upward revision in inflation forecasts.

  Risks

  If supply shocks intensify, the improvement in inflation could reverse further; if the conflict eases or supply recovers, inflation pressure could decline.

• Euro Area Inflation-Linked Assets

  Headline and core inflation forecasts have shifted back upward due to the energy path.

  Strengths

  The model framework directly links energy prices, price surveys, HICP, and wage indicators.

  Weaknesses

  Second-round effects are not yet confirmed, and evidence for persistent long-term inflation remains limited.

  Comparison

  The low energy forward price scenario had originally implied inflation below ECB forecasts, but the current scenario has returned close to the ECB baseline.

  Risks

  If inflation expectations or wages rise with a lag, inflation-linked assets may regain support.

Key data

• Number of model variables19 variablesCovers energy shocks, direct effects, indirect effects, second-round effects, and macro control variables.
• Model lag length6 lagsUsed to capture the dynamic transmission of energy shocks to downstream price and wage variables.
• Sample start point2003Most price variables are expressed in seasonally adjusted month-on-month terms, with observations through May or June 2026.
• Headline inflation gap under the low energy forward price scenarioAbout 0.4 percentage points below ECB staff projectionsBased on end-June low energy forward prices and softer price data.
• Core inflation gap under the low energy forward price scenarioAbout 0.2 percentage points below ECB staff projectionsSubsequent energy price increases brought the model-implied peak inflation forecast back close to the ECB baseline.
• Policy judgmentECB expected to deliver a second rate hike at the September meetingThe baseline is to hold steady thereafter, but risks tilt toward further tightening.

Impact & implications

The implication for investment and macro judgment is that the Euro Area disinflation trend remains highly dependent on the energy price path. If oil and gas prices stay high, ECB concern about a worsening inflation outlook will intensify, and rates markets will need to price in more persistent tightening risk; if energy pressures ease and second-round effects continue to be absent, the baseline scenario of a pause in subsequent hikes will have stronger support.

Risks

• Energy prices remain above current assumptions, causing the inflation outlook to deteriorate further and triggering more monetary tightening.
• Second-round effects may simply not have appeared yet rather than being entirely absent, so wages and long-term inflation expectations still need monitoring.
• The Middle East conflict, Russian refinery shutdowns, or other supply disruptions could increase oil and gas price volatility.
• If pass-through to core goods and services prices strengthens again, the current relatively benign core inflation view may be revised upward.
• The model relies on historical transmission relationships; if the current energy market, policy response, or inflation formation mechanism changes structurally, forecasts may deviate from reality.

What to watch

• Brent oil prices, TTF natural gas prices, European diesel prices, and their forward curves.
• Monthly changes in Euro Area HICP energy, core HICP, HICP services, and non-energy industrial goods prices.
• Whether PMI input prices, PMI output prices, and European Commission short-term inflation expectation indicators move higher again.
• One-year wage growth expectations in the ECB SAFE survey and negotiated wage data.
• The ECB September meeting decision, post-meeting communication, and whether it signals risks of further hikes.
• The duration and scope of the military conflict in the Middle East and disruptions at Russian refineries.