Central bankers around the world are confronting a difficult task: to infer how companies, labour organisations and consumers are adjusting their spending, pricing and wage decisions in response to a new energy shock associated with the Iran war. While policymakers are considering further rate increases to counter rising price pressures, they have made clear they will act only if they believe the jump in energy costs will spread into other prices and lift inflation expectations across the economy.
Assessing those expectations, however, is far from straightforward. Central banks possess a wide assortment of surveys, market gauges and other indicators, yet each of these tools has limitations or blind spots. Since the pandemic, authorities have added new instruments to fill gaps in behavioural data. Even so, many officials describe the exercise of reading expectations as more art than exact science - a reality that makes them reluctant to rely on instinctive judgements and more likely to wait for clearer evidence before tightening policy further.
Changes in behaviour since the 2022 inflation episode complicate readings
Officials note that the way households and firms respond to price pressures has shifted since the severe inflation episode in 2022. Richmond Federal Reserve Bank President Tom Barkin said he works to "get into the thoughts of price-setters and how they are seeing it - trying to calibrate their confidence in pricing power." He added that the case for additional hikes would hinge on "inflation expectations starting to finally move," and that he does not currently "have a sense that they’ve broken out at this point."
European Central Bank board member Isabel Schnabel highlighted that lived experience of past inflation may make expectations more fragile. She said people who endured the painful inflation episode may now be more sensitive to a new energy-price shock. Schnabel also pointed to a structural change in firms' price-setting. Where adjustments to selling prices were once a cumbersome, infrequent task done perhaps once a year, the post-pandemic period saw firms raise the frequency of price changes. That implies central banks need to watch how often firms alter prices as well as how large those changes are.
Traditionally, central banks relied on surveys and market-based measures to track expectations. Surveys, however, are often conducted too infrequently to capture rapid shifts and their typical time horizons do not always align with the near-term timeline policymakers are monitoring. Market-implied inflation measures are also imperfect because they incorporate risk premia - the extra return investors demand for holding particular instruments - which can vary with market sentiment and obscure pure shifts in expected inflation.
Market pricing and policy expectations
Investors have already priced in additional monetary tightening in several jurisdictions. Market participants now expect the European Central Bank to raise rates two or three times this year, the Bank of England to do so twice, and they have largely abandoned expectations of Fed rate cuts in 2026. Those market signals add pressure on central banks to interpret whether such moves reflect durable changes in inflation expectations or transient reactions to energy-price swings.
How central banks are trying to close information gaps
To address the shortfalls of conventional indicators, central banks have expanded their toolkit. They monitor expected wage developments, including large pay deals negotiated by unions that could influence other wage settlements. They conduct direct outreach to firms, holding surveys and conversations with executives to gauge planned behaviour. They also incorporate an increasing number of external forward-looking surveys and indicators into their assessments.
On the statistical side, central bank staff are tracking the frequency of price changes, adjusting existing survey data to correct for known gaps, and updating projection models after shortcomings were exposed by the 2022 surge in inflation that followed the pandemic and the war in Ukraine. These revisions are intended to improve the ability to detect whether a surge in energy costs will be absorbed or transmitted through wage and price-setting behaviour across sectors.
Context differs from four years ago - for now
Officials generally agree conditions today differ materially from the environment that produced the 2022 inflation spike. Interest rates have already been raised, fiscal positions are tighter, labour market slack is increasing and households no longer hold the large cash buffers typical of the pandemic period. Bank of England Governor Andrew Bailey summarised the prevailing view: "We’re coming into this situation with the gradual disinflation that we were having, the labour market is softening (and) growth is a little bit below potential," and noted consistent feedback from businesses of "a real lack of pricing power" across most sectors.
Against that backdrop, central bankers say they remain comfortable that longer-term inflation expectations are, for the moment, anchored close to their targets. Yet the durability of that anchoring is tied to how long the energy-price shock persists. If the conflict drags on and energy prices remain elevated, consumers facing higher day-to-day costs - for example filling their cars - could begin to revise upward their expectations for inflation, increasing the risk of second-round effects.
As ECB policymaker Primoz Dolenc put it: "Economics itself is not an exact science. It’s of course based on analytics but by definition there is also a perception and judgment element." That admission underscores that policy decisions will rest on a mix of quantitative evidence and subjective assessment, a combination that can raise the bar for acting pre-emptively on inflationary signals.
For now, central bankers are balancing a range of imperfect signals - from market pricing and wage settlements to firms' reported plans and revised statistical models - in order to decide whether the current energy shock will remain contained or spread into more persistent inflation. The outcome will shape decisions on interest rates in the months ahead and influence financial market pricing and economic sectors sensitive to interest costs and consumer demand.