By Marta Vilar – FRANKFURT (Econostream) – European Central Bank President Christine Lagarde said on Wednesday that the ECB could consider a “measured” policy adjustment if rising energy prices—linked to tensions in the Middle East—cause a significant but temporary spike in inflation.
In a speech at the ECB and its Watchers Conference in Frankfurt, Lagarde emphasized that the ECB must closely monitor how energy costs feed into broader inflation, particularly through wages and expectations.
Because such effects can be non-linear, the central bank is using scenario analysis and watching early warning indicators to detect whether price pressures are becoming more widespread, she said.
The ECB’s response would depend on how strong, long-lasting, and far-reaching the shock is, she said.
“Small, one-off and short-lived supply shocks can be looked through,” she said. “But as expected deviations from our inflation target grow larger and more persistent, the case for action becomes stronger.”
She highlighted that today’s situation differed from the 2022 inflation surge, which was amplified by higher gas prices, post-pandemic demand, labor shortages, and already elevated inflation, all of which “exacerbated the inflation effect.”
Currently, the economy was in “a moderate recovery”, with inflation near the ECB’s 2% target for about a year, and less acute labor shortages, she said.
However, she added that “there were reasons for vigilance,” referring to major disruptions in global oil supply, declining inventories, and the possibility that businesses and workers might react more quickly to inflation given recent experience.
The ECB would calibrate its monetary policy with “agility” and a “focus on risks,” she said.
The scenario analyses published by the central bank in its March meeting should not be considered as “forecasts” but as “illustrations,” she said, noting that they had been developed “under a no-policy-change assumption.”
“And we will review and update our scenario analysis regularly,” she added.
Lagarde described the current environment as non-linear in terms of inflation risks, adding that the effects on inflation and wages could accelerate as the shock became larger and more persistent.
“Because of these non-linearities, it is essential to identify as early as possible when the shock is at risk of broadening,” she said. “That means tracking closely the indicators that can signal ahead of time the size and timing of indirect and second-round effects.”
The ECB is monitoring indicators such as commodity prices, corporate pricing expectations, wage data, demand trends, and fiscal policy responses, she said.
While central banks traditionally either ignore supply shocks or respond forcefully when inflation expectations become deanchored, Lagarde said the ECB could act more gradually.
In the event of a limited shock in size and duration, the ECB should look through it, she said. However, if it were to generate a large but not-too-persistent overshoot of the inflation target, “some measured adjustment of policy could be warranted,” she added.
Failing to address an overshoot like this might represent a communication risk, she said.
If inflation were expected to rise significantly and persistently above target, however, the ECB would need to respond more decisively to prevent expectations from becoming unanchored, she said.
“It is too early to say where on this spectrum we will need to be,” she said. “Fortunately, we can assess the situation carefully, because we are entering this shock from a good starting point.”
Incoming data would give the ECB more clarity on the evolution of the conflict and the impact on the economy, she said, adding that the central bank would keep a close eye on developments.
“We will not act before we have sufficient information on the size and persistence of the shock and its propagation,” she said. “But we will not be paralyzed by hesitation: our commitment to delivering 2% inflation over the medium term is unconditional.”
