Stabilising the shock market

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The price of fossil fuels has been a trigger for most of the major inflationary episodes in the European Union (EU) over the past half-century, from the Organization of the Petroleum Exporting Countries (OPEC) embargo of 1973 to Russia’s invasion of Ukraine and now the war on Iran. New modelling by the New Economics Foundation (NEF) finds that fossil fuel price shocks play the most systemically significant role in headline inflation in all but two of the countries studied. We estimate that a 50% shock to these prices, comparable to the 47% rise in oil prices over the past year, would add between 0.8 and 1.8 percentage points to headline inflation across EU countries. Compared to the European Central Bank’s (ECB) 2% inflation target, these results are significant. Yet the monetary policy framework Europe built to fight inflation is not only ill-suited to containing these shocks, but it is also actively suppressing the transition to renewable energy that would end them. How Europe manages inflation is, in large part, a question of how it manages its energy system.

Strikes by the USA and Israel on Iran in February 2026 sent Brent crude from $70 to over $100 per barrel in two weeks, colliding with European gas storage at just 30% of capacity and adding an estimated €14bn to the EU’s fossil fuel import bill within 30 days. The ECB, which had only just ended its rate-cutting cycle as inflation returned to target, first postponed further reductions and then, in June 2026, raised rates for the first time since 2023, lifting the deposit facility rate to 2.25% even as the eurozone economy contracted. This mirrors its response to the gas crisis of 2022, when it raised the deposit facility rate from ‑0.5% to 4% in little over a year. In both cases, the ECB reached for interest rates, a tool designed to cool excess demand, in response to inflation originating in the supply of imported energy.

Our results suggest these sorts of price shocks will hit sectors differently. Unsurprisingly, electricity and fuel bills react most strongly to the shock, but effects also trickle through to food prices and transport and water supply services, with the effects on food having the largest impact on headline inflation of the three. Different countries also see different effects, and our results show Eastern European countries being particularly exposed due to a higher reliance on fossil fuels and a consumption basket more heavily weighted to goods and services that are more likely to be buffeted by shocks.

An initial shock does not necessarily have to translate into lasting inflation. Costs pass through gradually. How the burden is finally shared depends on the power of firms to raise prices, the power of workers to raise their incomes in response, and the power of governments and central banks to intervene. The empirical evidence reviewed in this report shows that, on average, workers have lost out. Real compensation in the EU fell by 4.3% in 2022 while profits rose in real terms in the same period. This is because workers’ bargaining power has reduced significantly in recent decades. Indeed, the ECB’s own economists found unit profits accounted for roughly two-thirds of domestic price pressures in 2022, compared with a historical norm of closer to one-third.

We argue that speeding up the transition is the only way to make Europe more resilient to volatile fossil fuel imports. The current electricity market design clearly underlines this argument. In the EU, gas set the marginal price of electricity 55% of the time in 2022 despite generating only 19% of the EU’s power. The International Monetary Fund (IMF) finds that each percentage point increase in the renewables share cuts wholesale electricity prices by 0.6% on average. Spain, having doubled its wind and solar capacity since 2019, saw fossil fuels set its power prices just 19% of the time in the first half of 2025, down from 75%, leaving wholesale prices 32% below the EU average. Unlike imported oil and gas, renewables are domestic, geopolitically secure, and shielded from financial speculation. The problem with hiking interest rates during a fossil fuel price increase is that rate hikes fall asymmetrically on technologies that could reduce future exposure.

This report therefore calls for a new macroeconomic settlement, built on much closer coordination between monetary and fiscal policy. We make the following proposals to reform macroeconomic governance:

• Recognise that energy resilience is key to price stability. Because fossil fuel dependence is the dominant source of the shocks that destabilise European prices, supporting the transition directly serves the ECB’s primary mandate over the medium term, with its secondary mandate under Article 127(1) TFEU providing a further, independent basis for action. The ECB should act deliberately on energy security, through green dual refinancing rates, a decarbonised collateral framework, and credit guidance.
• Coordinate monetary and fiscal policy around the type of shock. Interest rates may be suited to demand-driven inflation, but a supply shock is better met by fiscal and regulatory tools addressing the cost at source, with monetary policy keeping financing conditions compatible with the investment needed for medium-term price stability. Clarifying the ECB’s secondary mandate and convening a standing Economic Coordination Council to flag where monetary and fiscal stances pull against each other would achieve this through coordination, not subordination, without compromising central bank independence.
• Use dual interest rates to fund the green transition. By setting a separate, lower rate on targeted long-term refinancing tied to green lending, the ECB can keep financing conditions favourable for the transition even while it holds or raises the headline rate to contain demand, something it has already shown it can do through its targeted longer-term refinancing operations.
• Hold strategic buffers of systemically significant commodities. Physical reserves of gas and other critical energy commodities, released when prices spike, can blunt a shock before it propagates through the economy, providing a form of price-stability insurance that is cheaper than the damage it prevents.
• Strengthen the anti- pass-through toolkit now. With more supply-side inflation likely in the coming years, stronger competition enforcement, ongoing price surveillance and a permanent excess-profits tax on oil and gas should be put in place before the next crisis arrives rather than improvised in an emergency.

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