ROI-Iran oil shock prompts ECB hawks to seek 2021/22 rematch: Mike Dolan

By Mike Dolan

LONDON, March 12 (Reuters) - European Central Bank hawks are itching to rewrite the record. This month's energy price shock may not match the fallout from Russia's invasion of Ukraine, but officials are clearly wary of repeating the slow post-pandemic policy tightening that left them scrambling in 2022.

The debate within the ECB Governing Council will surely be intense over whether, how or when to respond to this potentially inflationary oil and gas price spike. Uncertainty about the course of the Iran conflict and the length of the related energy hiatus means few will want to decide much as soon as next week's policy meeting.

But financial markets aren't hanging about to find out who's going to win the argument. Money markets shifted on Tuesday to fully price an ECB interest rate rise by July - a seismic shift from the flat policy horizon seen only a few weeks ago, when markets were even flirting with the chance of one more cut earlier this year.

And hawks have been out in force - perhaps listened to by markets more closely now after recent speculation that ECB President Christine Lagarde may stand down early, as soon as this year.

One name touted as a possible successor, Bundesbank boss and well-known policy hawk Joachim Nagel, made his view clear on Wednesday.

"We must be very vigilant," Nagel told Reuters, adding that the debate about a possible inflation undershoot and further easing had ended.

"If it becomes apparent that the current energy price increases will translate into broad consumer price inflation in the medium term, the Governing Council of the ECB will act decisively in a timely manner."

"Timely manner" is doing a lot of heavy lifting in that comment.

That's likely because there's still a bruise at the ECB - and at many other major central banks - from the attempt to see through what was considered a "transitory" post-pandemic inflation surge, stoked mainly by economies rebooting from COVID-19 lockdowns and huge fiscal rescue spending.

Leaving ECB policy rates in negative territory even as headline euro zone inflation soared from 2% to almost 6% in the eight months through February 2022 probably hurts in hindsight.

ECB board member Isabel Schnabel went one further by saying on Wednesday there are "scars from this high-inflation episode."

NOT RELIANT ON LUCK

It may even have worked out okay back then too, but it left the whole picture very vulnerable to another left-field event.

Once Russia invaded Ukraine in February 2022 and sent natural gas and oil prices soaring - an event the central bank couldn't reasonably have predicted - euro zone inflation shot above 10% later that year.

The ECB eventually scrambled into action by July, lifting rates from below zero to 4% in just 14 months and returning inflation to target a year later. The price was steep: higher energy bills, general inflation and the sharp rate shock for businesses, households and the wider economy.

For many, that sequence of events may have been just unlucky - but it also displayed the risks of not moving quickly to head off above-target inflation, rising inflation expectations and second-round effects including business margin-padding and wage bargaining pressure.

The delay, they argue, meant the ECB eventually had to stamp on the brakes harder than would otherwise have been necessary.

Former Dutch central banker Klaas Knot, another name widely touted as a possible successor to Lagarde, made that very point late last week in a podcast with Brussels think tank Bruegel.

"The lessons (from 2021/22) are that while standard theory prescribes that you should look through a negative supply shock like an energy shock, you have to be very, very wary of non-linearities and second-round effects," Knot said.

"If necessary, if a similar response was warranted, then the ECB would look back to the playbook of 2022/23," he said.

There's plenty of argument against that still, of course - the most obvious one being that we don't know the extent and length of this Gulf energy hit yet, and overreaction may prove unnecessarily damaging.

ECB Vice President Luis de Guindos spoke on Wednesday of a need for cool heads and warned that stoked financial market volatility could cause its own problems.

For others the comparison with 2021/2022 is unfair because both fiscal and monetary policy were much looser back then than they are now - so the starting points are different.

Even Schnabel argued that the energy supply shocks are different now than four years ago - the earlier one being a more permanent cut of Russian gas and oil supplies and this month's likely a somewhat more temporary halt to Gulf exports.

For now, however, markets seem to favor the idea that the ECB will move more quickly to limit the need for subsequent harsher action down the road.

If oil and gas prices don't fall back very soon, an early shot across the bow to price-setters may well be in store.

(The opinions expressed here are those of the author, a columnist for Reuters.)

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