FRANKFURT (MNI) – Energy prices may remain volatile and rise
further as global growth recovers, which calls for a stability-oriented
monetary policy to minimize adverse impacts on the economy, the European
Central Bank said in a report published on Monday.

To further reduce the cost of energy price volatility, the euro
area must promote energy efficiency and greater economic flexibility,
the report, which analyzes the impact of energy price fluctuations on
the euro area economy, said.

The ECB warned that since “price gyrations over the last number of
years have been particularly dramatic,” the “outlook for energy markets
and prices remains uncertain in the long run.”

The report found that the “response of euro area output to large
energy price changes is determined by the energy dependency and the
intensity of production, as well as by the degree of flexibility of the
economy more generally.”

The higher the flexibility of an economy and the lower its energy
dependency, the lower the output loss as a result of higher energy
prices tends to be, the central bank said.

“Looking ahead, the main factors impacting on the future of euro
area energy markets point to a further reduction in the degree of energy
intensity, making the euro area economy less vulnerable to price
changes. However, energy dependency is expected to remain high and
energy prices may remain volatile,” the ECB said.

In addition, energy supply may have been hit “by the downscaling of
investment during the crisis, and tightness in the global energy market
may re-emerge as global activity growth resumes,” the central bank
warned.

“As regards inflation, first-round effects [via the energy prices
paid by consumers and energy costs in the production process] and
second-round effects [via wage and price-setting behavior more
generally] both contribute to the impact of energy prices on consumer
prices in a substantive way,” the ECB said.

“While monetary policy cannot address first-round effects, it
should tackle second-round effects by shaping inflation expectations,”
the report said.

“If monetary policy is not credible, inflation expectations can
become unanchored by energy price changes. However, in an environment
with a credible central bank, energy price fluctuations should not
affect inflation expectations over the medium to long term,” the ECB
said.

As monetary policy works with a lag, “a medium-term oriented
monetary authority looks through the short-term volatility of headline
inflation and does not attempt to fine-tune price and economic
developments,” the ECB noted.

“A more aggressive monetary policy response is however needed when
there are clear signs of second-round effects on prices”, as second
round effects such as wage and price indexation or higher pricing power
of firms “make the impact of transitory energy price increases on
inflation more persistent,” the ECB asserted.

–Frankfurt bureau; +49-69-720142; frankfurt@marketnews.com

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