A view from London

The energy shock has wrecked market hopes for interest rate cuts this year. Financial markets are now pricing in roughly 75bp of rate rises in the UK and the euro area by December.

Economists are less convinced of the need for, and the likelihood of, big interest rate rises this year. Against a backdrop of sluggish growth and rising unemployment many economists think higher energy prices will have only a transient effect on prices, with inflation falling back sharply in 2027.

The OECD also thinks the jolt to inflation will be short-lived. It does not expect higher energy prices to feed back into wages and other prices in the way that was seen after the 2022 energy shock. Indeed, the OECD thinks energy prices will have vanishingly little impact on underlying, or core inflation. This leads the OECD to the view that the global headline inflation rate will drop from 4.0% this year to 2.7% in 2027, only marginally above the 2.5% rate forecast in December.

A sceptic would point out that this sort of optimistic thinking led central banks to badly underestimate the inflationary effect of 2022’s energy price shock. I think that comparison is flawed. The world was in a different place in 2022. A post-pandemic explosion in demand was meeting constrained global supply; labour markets were running red hot and home-grown inflation was surging.

If the OECD is right and inflation fades next year, the world should be able to get by with only a short-term knock to growth.

This sanguine view comes with a huge caveat. The OECD forecasts assume that energy prices will decline from the middle of this year. If they don’t, things could be much worse. We know from history that energy shocks have, time and again, been harbingers of slowdowns or worse. More fundamentally, forecasting amid the sort of wild swings in news flow we are seeing every day can only, at best, give a point in time view. No one can have a high degree of conviction about the future without a view on how the conflict ends. And that is no less clear today than it was four weeks ago.