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Energy shock or inflation shock? Why the distinction matters

Investment Insights • Macro

2 min read

Energy shock or inflation shock? Why the distinction matters

Higher energy prices have lifted headline inflation across most economies, raising concerns about the implications for monetary policy and bond markets. Here, EFG Chief Economist Stefan Gerlach examines whether the energy shock is spreading to broader inflation and what this could mean for interest rates and long-term government bond yields.

Stefan Gerlach

Stefan Gerlach

Energy prices rose sharply following the US-Israeli strikes on Iran that began at the end of February. Headline inflation subsequently increased, while ten-year government bond yields rose markedly during the second quarter, as investors reassessed the persistence of inflation and the likely path of policy rates.

An important question for investors now is therefore whether the energy shock is generating broader inflation pressures. So far, there is surprisingly little evidence that it is.

Higher energy prices can spread to broader inflation in two ways. The first is through indirect effects. Higher energy costs raise firms’ production and operating costs and may therefore feed into the prices of other goods and services. The second is through second-round effects, as workers seek compensation for higher living costs and stronger wage growth, something that may subsequently push up prices.

Both effects may eventually become apparent in measures of inflation that exclude energy. The encouraging news is that there is little evidence of significant spillover effects so far.

The distinction is particularly clear in the US. Headline consumer price index (CPI) inflation rose sharply from 2.4% year-on-year in February to 4.2% in May as energy prices increased. It subsequently fell back to 3.3% in July.

In contrast, stripping out energy, inflation has been remarkably stable. It stood at 2.6% in February, peaking at 2.9% in May and has declined to 2.5% in July.

Inflation excluding energy therefore remains somewhat elevated, but there is little indication that the energy shock has generated renewed upward pressure on the prices of other goods and services.

A similar pattern is evident in the euro area. Headline Harmonized Index of Consumer Prices (HICP) inflation rose from 1.7% in January to 3.2% in May as the energy shock passed through to consumer prices. It has since declined to 2.9% in July. inflation excluding energy has moved much less. It was 2.3% in January, peaked at 2.4% in May and stood at 2.2% in July, only slightly above the European Central Bank’s 2% inflation objective. Again, the rise in headline inflation has not been accompanied by a comparable increase in broader inflation.

The UK provides another important test because inflation was already relatively high before the latest energy shock. Headline inflation stood at 3.8% in August 2025 before declining to 2.6% in June 2026. Inflation excluding energy similarly fell from 3.9% to 2.5%.

The key question will be whether the latest data show any sign that higher energy costs are interrupting this decline in underlying inflation. If inflation excluding energy remains broadly stable, the UK would reinforce the pattern visible in the US and euro area.

Switzerland provides perhaps the clearest example of the distinction between energy and broader inflation pressures.

Headline CPI inflation rose from around zero at the turn of the year to 0.6% in April and May before easing to 0.4% in July. Yet inflation excluding petroleum products has remained exceptionally weak, standing at just 0.1% in July.

The energy shock has therefore raised Swiss headline inflation without generating any discernible increase in broader price pressures.

Implications for monetary policy and bond markets

For central banks, there is an important difference between a temporary rise in inflation caused by an energy shock and a broader increase in prices throughout the economy.

If inflation continues to spread, policymakers may need to keep interest rates higher, or potentially tighten policy further. But if the impact remains largely confined to energy, the case for a significant monetary policy response becomes much weaker.

This distinction also matters for bond markets. The sharp rise in long-term government bond yields during the second quarter partly reflected concerns that higher inflation would prove persistent and require tighter monetary policy. If the energy shock remains largely confined to headline inflation, some of those concerns may ultimately prove excessive.

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