Why this oil shock isn’t like the last one
The new surge in oil prices will be shaped more by political responses than by monetary policy, due to a crucial shift in the economic backdrop from the tight labor markets of 2022 to the current looser conditions, says Helen Thomas
This week, six major central banks meet in quick succession, including the big four: the Federal Reserve, the European Central Bank, the Bank of Japan and the Bank of England. Investors are focused on what higher oil prices might mean for monetary policy. The scars of 2022 remain fresh. Back then, surging energy prices and spiralling inflation prompted an aggressive global tightening cycle. The Federal Reserve alone delivered four consecutive 75 basis point rate hikes, reshaping global financial conditions almost overnight.
Markets fear a repeat of central banks falling behind the curve if inflation accelerates. The scale and speed of the latest rise in oil prices has already surpassed the move seen in the immediate aftermath of Russia’s invasion of Ukraine. But focusing solely on central bank reactions risks missing a crucial shift in the economic backdrop.
In 2022, the oil shock collided with an unusually tight labour market. The global economy was reopening after pandemic lockdowns, migration flows had been disrupted, and companies across sectors were scrambling to hire workers to meet a surge in pent-up demand.
The result was a classic wage-price spiral. As headline inflation surged, workers demanded higher pay. Even when inflation began to ease, wage growth continued to run hot, often outpacing prices and keeping real wages broadly positive.
That dynamic forced central banks to act decisively. Higher energy prices risked embedding inflation across the entire economy via wage settlements and expectations.
Today, the picture looks very different.
Labour markets across major economies have largely returned to equilibrium. In the UK, the market is arguably loosening. In its latest Monetary Policy Report, the Bank of England highlighted the falling vacancy-to-unemployment ratio and shifts in the composition of unemployment as signs of emerging slack. Notably, the four policymakers who voted for a rate cut at the last meeting all pointed to signs that the economy was softening.
Cooling labout markets
The US labour market may also be cooling. A recent shock decline in non-farm payrolls has raised questions about whether the period of exceptional employment strength is finally coming to an end.
Taken together, these developments give central banks a plausible argument for “looking through” higher oil prices. Energy shocks typically act as a tax on consumers: they squeeze household budgets, weaken demand and ultimately slow economic growth. If labour markets remain contained, policymakers may feel they can tolerate a temporary spike in headline inflation without responding with higher interest rates.
But financial markets may be focusing on the wrong policy response. The real risk may not lie with monetary policy at all but rather with fiscal policy.
The inflation shock of 2022 left a deep imprint on public attitudes. Households have not forgotten the sudden surge in the cost of living, from grocery bills to petrol prices. And crucially, those prices never came back down.
Central banks operate with an annual inflation target. In their framework, bygones are bygones: they focus on the rate of change in prices rather than the cumulative level.
But consumers experience inflation very differently. If prices jump 10 per cent one year and then rise another two per cent the next, the official target may have been restored but the household budget has permanently ratcheted higher.
That lingering sense of loss matters politically.
Faced with rising fuel prices once again, governments around the world have already begun to act. South Korea has introduced a cap on gasoline prices. Brazil has cut diesel taxes. The Philippines has moved to suspend or reduce fuel excise taxes temporarily.
In the UK, the tension between political pressure and fiscal reality is already visible.
Energy Secretary Ed Miliband recently promised that the government would “stand by the British people in this crisis and do what it takes”. But the state of the public finances makes such pledges increasingly difficult to deliver.
Every bout of volatility in global bond markets tends to hit UK government debt particularly hard
Every bout of volatility in global bond markets tends to hit UK government debt particularly hard. Gilts have repeatedly sold off more sharply than their peers, reflecting investor sensitivity to Britain’s fiscal position.
As a result, policymakers are signalling that support will be tightly targeted rather than sweeping. The government has so far pledged £53m to help households that rely on heating oil, a figure deliberately measured in millions rather than the billions deployed during previous energy crises.
This reflects a broader global constraint. After the pandemic, many governments are already carrying historically high debt burdens. The fiscal “blank cheque” era of emergency subsidies and universal support is largely over.
Even energy-producing countries are reassessing their policies. Malaysia, which long maintained blanket petrol subsidies, has begun shifting towards targeted support after building a national socio-economic database that allows benefits to be directed to vulnerable households.
Events are moving faster than policy frameworks.
Central bank interest rate decisions cannot put fuel into delivery trucks or gas into restaurant kitchens. In India’s state of Maharashtra, for example, more than a third of restaurants registered with the Indian Hotel and Restaurant Association have reportedly cut back operations due to the squeeze on natural gas supplies.
The next phase of the oil shock may therefore be shaped less by monetary tightening and more by political responses such as targeted subsidies, tax cuts, price caps and other fiscal interventions.
For investors, that shift matters. Fiscal responses alter government borrowing needs, reshape bond markets and influence inflation dynamics.
The memories of the pandemic and the inflation surge that followed have changed how both policymakers and the public react to crises.
Financial markets would be wise to look beyond central bank meeting rooms and pay closer attention to the political economy of higher energy prices.
Helen Thomas is founder and CEO of Blonde Money