ING’s James Smith argues that Europe’s resilience reflects contained inflation rather than excessively loose monetary policy, leaving markets vulnerable after pricing several additional rate hikes
Takeaways
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ING’s James Smith finds that energy is contributing less than one quarter as much to eurozone inflation as it did during the 2022 crisis, while indirect energy-sensitive inflation has barely moved.
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Food inflation, wage sensitive inflation and corporate selling price expectations remain benign. The hawkish case depends increasingly on a delayed pass-through that has yet to appear in the data.
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Markets may be mistaking Europe’s relief from a smaller inflation shock for evidence that monetary policy is too loose. ING sees a September ECB hike as defensible, but several additional European hikes look increasingly difficult to justify
Europe’s Inflation Shock Is Still Missing
Six months after the Iran War began, Europe has avoided the economic outcome that appeared almost inevitable when energy routes through the Strait of Hormuz were disrupted.
Growth has held together. Inflation has not taken flight. The stagflation forecasts that arrived almost as quickly as the missiles have quietly been folded away.
That does not mean Europe escaped untouched. Oil and natural gas prices rose, household energy bills increased, and businesses were forced to absorb another round of uncertainty. But ING economist James Smith argues that this shock has been considerably milder than the energy crisis following Russia’s invasion of Ukraine.
The distinction matters because markets have moved well beyond pricing resilience. They are now pricing at least two additional rate hikes from both the European Central Bank and the Bank of England.
Smith’s research suggests that 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. It may simply have avoided freezing.
This Is Not 2022
By July 2022, energy was contributing approximately four percentage points to eurozone inflation. Today, the contribution is less than one quarter of that amount.
Britain tells a similar story.
Even with the latest increase in European natural gas prices, Smith does not expect the comparison to change dramatically. The present energy shock remains meaningful, but it has not approached the force of the one that followed the Ukraine invasion.
Source: Macrobond, ING
The difference begins with the starting point.
Europe entered the Ukraine crisis deeply dependent on Russian pipeline gas and without a ready replacement. The abrupt disruption forced governments and businesses to compete for liquefied natural gas while storage facilities, import terminals and supply contracts were still being reorganised.
Four years later, Europe possesses a more diversified energy network, greater experience managing shortages and businesses that have already reduced some of their energy intensity.
The Strait of Hormuz disruption has been serious, but it has not removed the central artery of Europe’s energy system in the way the loss of Russian pipeline supplies once threatened to do.
That smaller direct shock has also produced less pressure beneath the surface of the inflation basket.
The Pass-Through Has Barely Started
Smith has recreated an index previously developed by the ECB that tracks goods and services indirectly sensitive to energy prices.
The basket represents roughly one third of eurozone inflation and includes items such as airfares, courier services, plants and cafés. These prices are not energy bills, but energy forms part of their production and operating costs.
The result is surprisingly calm.
Source: Macrobond, ING
From this measure alone, it would be difficult to know that Europe had spent six months navigating a major war and a disrupted energy route.
Energy-sensitive inflation has barely moved.
That is not proof that the entire effect has passed. Smith acknowledges the argument made by ECB hawks: indirect inflation tends to follow energy prices with a delay of approximately six months.
The café owner does not change the price of a cappuccino the morning wholesale gas rises. The higher cost must first reach the energy contract, then survive the owner’s margins, and finally become sufficiently persistent to justify passing it to the customer.
That process takes time.
The hawkish argument is therefore not foolish. The inflation pulse may still be moving through the economy, and Smith expects next week’s data to show some further increase.
But a lag is not the same as a guarantee.
The longer the indirect measures remain subdued, the more evidence policymakers should require before assuming that the full historical pass through will eventually arrive.
Britain’s Inflation Basket Is Even Calmer
The UK evidence looks more benign still.
Using energy intensity data from the Office for National Statistics, Smith finds that inflation among energy intensive goods and services has actually declined this year. That remains true even after excluding the temporary distortions created by last year’s increases in water bills and road taxes.
Source: Macrobond, ING
This is not what an economy on the edge of another broad energy inflation shock should look like.
Britain remains vulnerable to imported energy prices, and household bills can still respond sharply when regulated price caps reset. But the corporate pass through visible in the underlying inflation basket is moving in the wrong direction for anyone trying to build a confident case for several Bank of England hikes.
Markets are effectively wagering that today’s resilience proves policy is too accommodative.
Smith’s argument is almost the reverse. Resilience may be the product of inflation failing to inflict the expected damage on household purchasing power.
The economy is holding up because the shock was smaller, not necessarily because demand is running too fast.
Food Is the Dog That Has Not Barked
If the Iran War were beginning to infect broader European inflation, food would be one of the first places to look.
Food production, fertiliser, refrigeration, processing and transport are all exposed to energy costs. Consumers also purchase food frequently, making supermarket prices particularly important for inflation expectations.
Yet food inflation is declining across Western and Central Europe.
In Britain, the level of food prices is lower than it was three months ago. Across the three largest Eastern European economies, annual food inflation has turned negative.
Source: Macrobond, ING
Most economic models still suggest that the maximum food price effect from the Iran War will not appear until next spring. But those same models indicate that at least some pressure should already be visible.
It is not.
For Smith, that should reassure policymakers for two reasons.
First, food is one of the clearest transmission points between energy costs and household inflation. If the shock were broadening, the supermarket aisle should already be beginning to whisper about it.
Second, food prices play an outsized role in consumer inflation expectations. Households may not know the current yield on a , but they know what bread, milk and vegetables cost.
Lower food inflation reduces the risk that households begin treating the energy shock as a permanent change in the price level.
That matters because expectations become dangerous only when they alter behaviour. Workers must demand higher wages, companies must increase prices and the process must begin feeding on itself.
So far, that loop has not formed.
Wage Pressure Is Easing, Not Accelerating
Smith also reconstructs the ECB’s measure of wage sensitive eurozone inflation.
It has declined throughout 2026.
Source: Macrobond, ING
Wages are slow moving and often the final stage of an inflation shock. Employers do not renegotiate salaries every time oil rises, and workers require both bargaining power and confidence before demanding compensation for higher living costs.
There has been a modest increase in advertised salary growth, according to hiring data from Indeed. But Smith notes that this does not align with the ECB’s forward looking measure of negotiated wages.
The broader evidence suggests that workers do not possess the bargaining power required to convert the energy shock into a lasting wage price cycle.
Companies are not behaving as though such a cycle is imminent either.
The proportion of eurozone service businesses expecting to raise selling prices has shown no meaningful acceleration.
Source: Macrobond, ING
This final chart closes the inflation chain.
Direct energy inflation is much smaller than in 2022. Indirect energy-sensitive inflation has barely moved. Food inflation is falling. Wage-sensitive inflation is easing. Businesses are not preparing a new round of price increases.
The hawkish case rests heavily on what might happen after the lag.
The dovish case rests on what is actually happening now.
Growth Has Improved, but the Reason Matters
ECB officials can point to firmer confidence surveys and respectable Purchasing Managers’ Indices. Germany’s defence expansion and infrastructure spending are also providing real support.
But Smith asks the more important question: is Europe growing because monetary policy is too loose, or because inflation has been less damaging than feared?
That distinction separates a genuine overheating economy from an economy that simply dodged a recession.
The argument that neutral interest rates have risen materially above the commonly assumed 2 percent to 2.5 percent range is plausible in the United States. America is experiencing enormous AI investment, strong equity markets and resilient domestic demand.
The European evidence is far less convincing.
Europe’s manufacturing sector has even received an unexpected benefit from the Strait of Hormuz closure. Asian competitors faced more acute disruptions to energy supplies and shipping routes, allowing some European manufacturers to capture additional orders.
That is a useful cushion. It is unlikely to become a permanent growth engine.
When trade routes normalise, some of those orders can move back. Policymakers should therefore be careful about treating temporary relative resilience as proof that the European economy can comfortably absorb several additional hikes.
The Rate Market May Be Leaning Too Far
Markets are pricing at least two further hikes from both the ECB and the Bank of England. Expected policy rates one year from now sit approximately one percentage point above where they were before the war.
Smith does not rule out an ECB hike in September. Rising natural gas prices and the delayed inflation pass-through give Frankfurt a defensible reason to move once more.
The case becomes much weaker after that.
Additional hikes would push policy further into restrictive territory without compelling evidence that the energy shock is spreading through food, wages, services or corporate pricing.
The Bank of England may face an even more awkward reassessment. UK energy-intensive inflation is declining, wage pressure is easing and the underlying economy hardly resembles one demanding a prolonged tightening cycle.
Smith believes it may not be long before the conversation turns toward the first UK rate cut.
That is the market tension sitting behind ING’s six charts.
The hawks are pricing the inflation that history says should arrive with a lag. The current data show an economy where the shock keeps knocking on doors but has not yet found a way inside.
One more ECB hike may be insurance.