The policy backdrop today looks materially different from the last energy crisis four years ago. The European Central Bank enters this episode from a position of relative strength. Inflation is close to target and labour markets, while cooling, are not deteriorating sharply.

Past episodes show that central banks typically do not tighten purely in response to oil led inflation scares unless demand conditions are exceptionally strong. Unlike the Federal Reserve or the Bank of England, the ECB is not being pulled in opposing directions by weakening employment and stubbornly high inflation. 

However, the fiscal picture is more complicated. In aggregate, Europe has fiscal space to provide support as the region’s debt dynamics are manageable. But Europe is not a fiscal union and lacks an effective mechanism to deploy that collective capacity. EU leaders have signalled that support should be temporary and targeted, but the risk is that member states may be tempted to do something bigger, but they face budgetary constraints. 

In the absence of a coordinated response, fiscal support risks being limited and uneven.

Unlike the post invasion period following Russia’s war in Ukraine, the current shock is likely to be felt by the real economy, with inflation relatively contained by comparison, potentially still reaching mid-single digits but falling well short of the post 2022 surge in severity.

Higher energy prices act as a classic supply shock, raising costs for households and producers and ultimately weighing on activity. Growth concerns are therefore likely to dominate the next phase of market pricing, particularly if tighter financial conditions persist.

In 2022, inflation absorbed the bulk of the adjustment, surging into double digits while GDP proved resilient, supported by post pandemic reopening momentum and policy stimulus. This time, however, growth will be the primary adjustment channel as higher energy costs, weaker confidence and constrained fiscal responses suppress investment.

ECB policymakers have revised 2026 GDP growth down by around 0.3 percentage points as higher energy costs and uncertainty weigh on consumption and investment. 

Italy illustrates these dynamics most clearly. An improving pre conflict narrative of greater political stability and stronger fiscal outcomes is now under pressure. Italy’s high exposure to LNG imports, combined with its energy intensive, manufacturing heavy economy, means sustained energy disruption raises more fundamental questions about its growth model.

Beyond Italy, the geopolitical dimension cannot be ignored. Russia is emerging from this conflict, economically strengthened, benefiting from elevated energy revenues. Europe’s decision to phase out Russian LNG imports by 2027 has been met with the prospect that Russia may simply stop supplying earlier, selling elsewhere at higher prices. 

It also raises the urgency around defence spending. Commitments have been made, but only a handful of countries have fully costed them. Higher defence outlays, combined with energy support for households and firms, risk pushing national budgets towards their limits. Without a collective fiscal response, these pressures will be difficult to reconcile.