Lagarde says ECB may tighten policy for inflation surge
Lagarde said the ECB may tighten policy even for a temporary inflation overshoot. She noted that failing to act could create risks for bank communication.
European Central Bank President Christine Lagarde indicated on Wednesday that even an inflation overshoot that is not considered highly persistent could trigger a moderate tightening of monetary policy. Speaking in Frankfurt, Germany, Lagarde noted that the current energy shock might require the central bank to act to prevent price growth from becoming entrenched in the economy.
The ECB maintained interest rates at their current levels last week but issued warnings regarding an anticipated surge in consumer prices. Policymakers are currently evaluating various economic scenarios to determine the appropriate timing for interest rate adjustments.
"If the shock gives rise to a large though not-too-persistent overshoot of our target, some measured adjustment of policy could be warranted," Lagarde said.
Lagarde emphasized the importance of maintaining clear communication with the public. She suggested that failing to respond to a significant deviation from inflation targets could damage the central bank's credibility.
"To leave such an overshoot entirely unaddressed could pose a communication risk: the public may find it difficult to understand a reaction function that does not react."
The central bank's current baseline projections suggest inflation will average 2.6% this year, up from approximately 2% in the previous year. However, more pessimistic scenarios are being considered. In an adverse scenario, inflation could peak above 4% in the latter half of 2026 before returning to target by mid-2027. A more severe outlook envisions inflation peaking above 6% early next year and remaining elevated for several years.
"If we expect inflation to deviate significantly and persistently from target, the response must be appropriately forceful or persistent," Lagarde added.
The ECB is closely monitoring early indicators that the energy shock is filtering into the broader economy, particularly through wage negotiations and inflation expectations. Lagarde noted that as deviations from the target become more pronounced, the argument for policy intervention strengthens.
"As expected deviations from our inflation target grow larger and more persistent, the case for action becomes stronger."
Financial markets are currently pricing in two to three interest rate hikes this year, reflecting investor concerns that inflation may remain above the 2% target for an extended period. Some analysts argue for early, smaller adjustments to avoid the criticism the ECB faced during the 2021-2022 inflationary period, when rates were not raised until inflation reached 8%.
Lagarde argued that the current economic environment differs significantly from that period. She pointed out that the current energy shock is smaller, particularly in the case of natural gas. Furthermore, the labor market is not as tight, there is no post-pandemic pent-up demand, fiscal policies are tighter, and the central bank rate is higher. She also noted that historical evidence suggests a broad pass-through from energy prices is the exception rather than the rule.
